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entitled 'Cayman Islands: Business and Tax Advantages Attract U.S.
Persons and Enforcement Challenges Exist' which was released on July
24, 2008.
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Report to the Chairman and Ranking Member, Committee on Finance, U.S.
Senate:
United States Government Accountability Office:
GAO:
July 2008:
Cayman Islands:
Business and Tax Advantages Attract U.S. Persons and Enforcement
Challenges Exist:
GAO-08-778:
GAO Highlights:
Highlights of GAO-08-778, a report to the Chairman and Ranking Member,
Committee on Finance, U.S. Senate.
Why GAO Did This Study:
The Cayman Islands is a major offshore financial center and the
registered home of thousands of corporations and financial entities.
Financial activity in the Cayman Islands is measured in the trillions
of dollars annually. One Cayman building—Ugland House—has been the
subject of public attention as the listed address of thousands of
companies.
To help Congress better understand the nature of U.S. persons’ business
activities in the Cayman Islands, GAO was asked to study (1) the nature
and extent of U.S. persons’ involvement with Ugland House registered
entities and the nature of such business; (2) the reasons why U.S.
persons conduct business in the Cayman Islands; (3) information
available to the U.S. government regarding U.S. persons’ Cayman
activities; and (4) the U.S. government’s compliance and enforcement
efforts. GAO interviewed U.S. and Cayman government officials and
representatives of the law firm housed in Ugland House, and reviewed
relevant documents.
What GAO Found:
The sole occupant of Ugland House is Maples and Calder, a law firm and
company-services provider that serves as registered office for the
18,857 entities it created as of March 2008, on behalf of a largely
international clientele. According to Maples partners, about 5 percent
of these entities were wholly U.S.-owned and 40 to 50 percent had a
U.S. billing address. Ugland House registered entities included
investment funds, structured-finance vehicles, and entities associated
with other corporate activities.
Gaining business advantages, such as facilitating U.S.–foreign
transactions or minimizing taxes, are key reasons for U.S. persons’
financial activity in the Cayman Islands. The Cayman Islands’
reputation as a stable, business-friendly environment with a sound
legal infrastructure also attracts business. This activity is typically
legal, such as when pension funds and other U.S. tax-exempt entities
invest in Cayman hedge funds to maximize their return by minimizing
U.S. taxes. Nevertheless, some U.S. persons have used Cayman Island
entities, as they have entities in other jurisdictions, to evade income
taxes or hide illegal activity.
Information about U.S. persons’ Cayman activities comes from self-
reporting, international agreements, and other sharing with the Cayman
government. The completeness and accuracy of self-reported information
is not easily verified. While U.S. officials said the Cayman government
has been responsive to information requests, U.S. authorities must
provide specific information on an investigation before the Cayman
government can respond.
The Internal Revenue Service has several initiatives that target
offshore tax evasion, including cases involving Cayman entities, but
tax evasion and crimes involving offshore entities are difficult to
detect and to prosecute. Cayman officials said they fully cooperate
with the United States. Maples partners said that ultimate
responsibility for compliance with U.S. tax laws lies with U.S.
taxpayers. U.S. officials said that cooperation has been good and that
compliance problems are not more prevalent there than elsewhere
offshore.
Figure: Ugland House, George Town, Grand Cayman Island:
[See PDF for image]
This figure contains a photograph of Ugland House, as well as the
following supporting text:
Ugland House:
* Sole tenant is Maples and Calder law firm, which provides registered
office services to companies established in the Cayman Islands;
* 18,857 registered entities at the Ugland House address;
- Very few have a significant physical presence in the Cayman Islands;
- Five percent wholly U.S. owned;
- Fewer than 50 percent have a U.S. billing address.
Source: GAO photograph and statistics obtained from the Cayman Islands
government and Maples.
[End of figure]
What GAO Recommends:
GAO makes no recommendations in this report. The Commissioner of
Internal Revenue, the Secretary of the Treasury, and the Leader of
Government Business of the Cayman Islands were provided a draft of this
report for review and comment. GAO received technical corrections which
were incorporated as appropriate.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-778]. To view the
E-supplement, click on [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-08-1028SP]. For more information, contact Michael
Brostek at (202) 512-9110 or brostekm@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
U.S. Persons Are Frequently Associated with Ugland House Registered
Entities:
Several Factors Influence U.S. Taxpayers' Decisions to Conduct
Financial Activity in the Cayman Islands:
The U.S. Government Has Access to Several Information Sources Regarding
U.S. Taxpayers' Business Activities in the Cayman Islands, but Most
Information Is Self-Reported:
U.S. and Cayman Officials Have Taken Steps to Address Illegal Activity,
but Enforcement Challenges Exist:
Concluding Observations:
Agency and Cayman Islands Government Comments:
Appendix I: Comments from the Cayman Islands Government:
Appendix II: GAO Contacts and Staff Acknowledgements:
Figures:
Figure 1: Cayman Islands Demographics and Financial Industry
Statistics:
Figure 2: Ugland House:
Figure 3: Ugland House Entities by Type, March 2008:
Figure 4: U.S. Persons' Involvement in Cayman Master-Feeder Hedge Fund
Structure:
Figure 5: U.S. Persons' Involvement in Cayman Structured Investment
Vehicles:
Figure 6: U.S. Persons' Involvement in Cayman Aircraft Financing
Special Purpose Vehicles:
Figure 7: U.S. Persons Reporting Cayman Islands Foreign Bank Accounts,
2002-2007:
Figure 8: U.S.-Related SARs Disclosed to FinCEN by CAYFIN in 2006-2007
by Type of Offense:
Abbreviations:
AML: Anti-Money Laundering:
ABS: Asset-backed securities:
CFATF: Caribbean Financial Action Taskforce:
CIMA: Cayman Islands Monetary Authority:
CAYFIN: Cayman Islands Financial Reporting Authority:
Justice: Department of Justice:
Treasury: Department of Treasury:
Ex-Im: Export-Import Bank:
FinCEN: Financial Crimes Enforcement Network:
IRS: Internal Revenue Service:
IOSCO: International Organization of Securities Commissions:
LMSB: IRS Large and Mid-Sized Business Division:
SBSE: IRS Small Business/Self-Employed Division:
KYC: Know-Your-Customer:
OPIC: Overseas Private Investment Corporation:
OFC: Offshore financial center:
MBS: Mortgage-backed securities:
MOU: Memorandum of Understanding:
MLAT: Mutual Legal Assistance Treaty:
FBAR: Report of Foreign Bank and Financial Accounts:
SEC: Securities and Exchange Commission:
SPEs: Special Purpose Entities:
SPVs: Special Purpose Vehicles:
SIVs: Structured Investment Vehicles:
SAR: Suspicious Activity Report:
TIEA: Tax Information Exchange Agreement:
SPC: Segregated Portfolio Company:
UBIT: Unrelated business income tax:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
July 24, 2008:
The Honorable Max Baucus:
Chairman:
The Honorable Charles E. Grassley:
Ranking Member:
Committee on Finance:
United States Senate:
The Cayman Islands is a major center for financial services, with
nearly 2 trillion dollars in banking assets as of September 2007.
International financial activity is common in our increasingly global
economy, and is encouraged or facilitated by various federal policies.
Nevertheless, financial activity across foreign jurisdictions poses
challenges for both tax policy and administration.
Recognizing the serious problem posed by offshore tax evasion, you
asked us to study what is known about the business activities of U.S.
taxpayers involving Ugland House in the Cayman Islands. Specifically,
you asked us about the extent, motives, and tax implications of these
activities, as well as the extent to which the U. S. government has
looked into these taxpayer activities. This report focuses on these
activities. Our objectives were to determine (1) the nature and extent
of U.S. persons' involvement with Ugland House registered entities, and
what business, if any, these entities carry on in Ugland House and in
the Cayman Islands;[Footnote 1] (2) what reasons attract U.S. persons
to conduct business in the Cayman Islands; (3) what information is
available to the U.S. government regarding U.S. persons' Cayman Islands
activities, including which are associated with U.S. taxpayers; and (4)
for tax noncompliance and other related illegal activities, the U.S.
government's compliance and enforcement efforts, and any related
activity on the part of the Cayman Islands government.
To address our objectives, we reviewed and analyzed U.S. government and
private sector documents and reports related to international finance,
offshore jurisdictions and tax havens, tax evasion and money
laundering, and the tax gap. With regard to U.S. government knowledge
related to Cayman Islands activities, we reviewed documentation from
the Internal Revenue Service (IRS), Securities and Exchange Commission
(SEC), the Department of the Treasury (Treasury) Financial Crimes
Enforcement Network (FinCEN)[Footnote 2] and International Affairs
Office, the Department of Justice (Justice), the Overseas Private
Investment Corporation (OPIC) , and the Export-Import (Ex-Im) Bank of
the United States. We also interviewed officials from these agencies,
and examined agency data for records related to Ugland House and the
Cayman Islands. In addition, we identified 21 civil and criminal cases
involving the Cayman Islands from DOJ, SEC, and IRS, as well as through
searches of legal databases. We asked officials from the agencies to
provide any cases known to them involving Cayman Islands and/or Ugland
House entities. Our database searches looked for cases where recent
Cayman Islands activity was central to the matter in question,
including those with an Ugland House or Maples and Calder connection.
The 21 cases ranged from cases in their investigatory stage to cases
that were fully resolved. At the time of our review, none of the
resolved cases had resulted in the subject of the investigation being
exonerated. In order to describe the characteristics of these cases,
they were separately reviewed by two individuals.
To determine the number of SEC filers located in the Cayman Islands, we
searched SEC's EDGAR database, a publicly available online database
that allows searches based on a number of criteria. To determine the
number of controlled foreign corporations that filed tax returns with
IRS in tax year 2004, we analyzed IRS's database of Controlled Foreign
Corporations.
Finally, we traveled to the Cayman Islands and interviewed Cayman
Islands government officials, including the Cayman Islands Solicitor
General, the Cayman Islands Financial Secretary, and officials from the
Cayman Islands Financial Reporting Authority, Tax Information
Authority, General Registry, and Monetary Authority, as well as senior
partners with the law firm of Maples and Calder (Maples). While in the
Cayman Islands we also collected and reviewed documentation from the
Cayman Islands government and Maples. We also reviewed a total of 133
instances of new business contacts that Maples received over a period
of 2 separate weeks--41 from December 2007 and 92 from March 2008--that
could have led to the formation of a Cayman Islands entity. A summary
of relevant U.S. and Cayman Islands laws and regulations can be found
in the E-supplement to this report, Cayman Islands: Review of Cayman
Islands and U.S. Laws Applicable to U.S. Persons' Financial Activity in
the Cayman Islands[Footnote 3]. We determined that the data from the
various sources were sufficiently reliable for purposes of this report.
We conducted our work from July 2007 to July 2008 in accordance with
generally accepted government auditing standards. Those standards
require that we plan and perform the audit to obtain sufficient,
appropriate evidence to provide a reasonable basis for our findings and
conclusions based on our audit objectives. We believe that the evidence
obtained provides a reasonable basis for our findings and conclusions
based on our audit objectives.
Results in Brief:
The international law firm of Maples and Calder, with its associated
businesses--Maples Corporate Services Limited and Maples Finance
Limited--is the sole occupant of Ugland House. Similar to corporate
service providers in the U.S., Maples Corporate Services Limited
provides registered office services, using Ugland House as a registered
address, to entities that Maples and Calder establishes. Registered
office services include activities such as maintenance of certain
entity records, and filing of statutory forms, resolutions, notices,
returns, or fees. Very few Ugland House registered entities have a
significant physical presence in the Cayman Islands, or carry out
business in the Cayman Islands. According to Maples and Calder
partners, the persons establishing these entities are typically
referred to Maples by counsel from outside the Cayman Islands, fund
managers, and investment banks. As of March 2008 the Cayman Islands
Registrar reported that 18,857 entities were registered at the Ugland
House address. Maples and Calder senior partners told us that
approximately 5 percent of those entities were wholly owned by U.S.
persons and 40 to 50 percent were U.S.-related in that their billing
address was in the United States. A U.S. billing address does not
necessarily imply U.S. ownership or control. Ugland House registered
entities are often participants in investment activities, such as those
related to hedge funds or private-equity funds, and structured finance
activities, such as securitization or aircraft finance. Other Ugland
House registered entities involve corporate subsidiaries and holding
companies, such as those used by multinational corporations to conduct
international business.
U.S. persons who conduct financial activity in the Cayman Islands
commonly do so to gain business advantages, such as facilitating U.S.-
foreign transactions or minimizing taxes; while much of this activity
is legal, some is not. Factors that attract U.S.-related financial
activity to the Cayman Islands include its reputation for stability and
compliance with international standards, its business-friendly
regulatory environment, and its prominence as an international
financial center. Examples of the wide variety of business reasons for
conducting financial activity in the Cayman Islands include attracting
foreign investors or taking advantage of the Cayman Islands insolvency
laws, which provide specific protections for creditors and investors.
Another frequent reason for doing business in the Cayman Islands is to
obtain tax advantages. The Cayman Islands is an offshore financial
center (OFC) that has no direct taxes and attracts a high volume of
nonresident financial activity from the United States and elsewhere.
U.S.-based corporations may legally use Cayman entities to minimize
U.S. taxes in a number of ways, for instance by creating Cayman
entities to earn amounts from active business transactions with
unrelated persons, which are not generally taxed in the United States
unless repatriated. Approximately 5.5 percent of the nearly $362
billion repatriated between 2004 and 2006 was from Cayman Islands
controlled foreign corporations. As another example, U.S. tax-exempt
entities, such as university endowments and pension funds, may invest
in hedge funds organized in the Cayman Islands because doing so allows
them to legally maximize their investment return by minimizing U.S.
taxes. Lastly, as with other offshore jurisdictions, some U.S. persons
may establish entities in the Cayman Islands to illegally evade taxes
or avoid detection and prosecution of illegal activities, as
illustrated by 21 criminal and civil cases we analyzed involving U.S.
persons suspected of offenses including tax evasion, money laundering,
and securities fraud. Because U.S. regulators have limited means of
collecting information regarding foreign entities, some persons intent
on breaking U.S. law may create such entities to obscure their
activities.
The U.S. government has access to several information sources about
U.S. persons' business activities in the Cayman Islands, although
limitations exist regarding the nature of information available and its
completeness because it is self-reported. Some information on U.S.
persons' Cayman Islands activities is reported to U.S. regulators such
as SEC and IRS. For example, for tax year 2004, U.S. taxpayers reported
about 1,400 controlled foreign corporations incorporated in the Cayman
Islands to IRS. In fiscal year 2007, 732 companies traded on U.S. stock
exchanges reported to SEC that they were incorporated in the Cayman
Islands. However, SEC and IRS information is largely self-reported and,
like other self-reported information, its completeness and accuracy
cannot be easily verified. When they have adequate identifying
information, U.S. officials can formally request information regarding
U.S. persons' Cayman Islands activities through established channels
such as the Tax Information Exchange Agreement (TIEA), which IRS has
used a small number of times since it went into effect in 2004 to
exchange information related to civil and criminal tax investigations
or the Mutual Legal Assistance Treaty (MLAT), which has been used over
200 times since 1990 to exchange information related to criminal
violations. Cayman Islands and U.S. officials also have other channels
for information sharing, such as coordination among regulatory
officials and sharing of financial intelligence information on
activities involving U.S. persons. U.S. officials from multiple
agencies said that the Cayman Islands government has been cooperative
in responding to U.S. requests, and shared useful information at their
initiative related to questionable financial activities that involve
U.S. connections.
The U.S. and Cayman Islands governments have taken steps to address
instances of U.S. persons' use of Cayman Islands entities to perpetrate
illegal activity, but enforcement challenges exist. While not limited
to the Cayman Islands, "hiding income offshore" is number 5 on IRS's
list of 12 most egregious tax schemes and scams for 2008. To address
the challenge posed by this activity, the IRS Large and Mid-Sized
Business (LMSB) and Small Business/Self-Employed (SBSE) divisions have
targeted abusive transactions in areas such as hedge funds, offshore
credit cards, and promoters of offshore shelters in numerous
jurisdictions. Although the full extent of Cayman involvement is
unclear, U.S. officials also described several criminal investigations
and prosecutions involving the Cayman Islands. For example, in 45
instances over the past 5 years IRS field agents have requested
information regarding suspected criminal activity involving the Cayman
Islands from the IRS official responsible for the Caribbean. An IRS
official said that there were fewer criminal investigations involving
the Cayman Islands than in some other offshore jurisdictions. IRS
officials told us that concealing ownership and income often occurs
through the use of a combination of entities spread across multiple
jurisdictions, which can hinder detection efforts. This
multijurisdictional and multientity character of some offshore activity
presents one of several enforcement challenges. Despite these
challenges, U.S. officials consistently report that cooperation by the
Cayman Islands government in enforcement matters has been good. In
addition to collaborating in support of U.S. efforts, the Cayman
Islands government has also taken steps to address illegal activity by
U.S. persons. For instance, the Cayman Islands was cited by the
Caribbean Financial Action Task Force (CFATF), an international task
force, as having a "strong compliance culture" related to combating
financial crimes and terrorist finance and has implemented a regulatory
regime that the International Monetary Fund (IMF) has deemed to be
generally in compliance with a broad range of international standards.
Maples and Calder partners noted the responsibility of U.S. owners of
offshore entities to comply with U.S. tax laws, and Cayman government
officials said that the Cayman Islands is "neutral" concerning U.S. tax
issues until it receives a request for assistance from the United
States.
We provided a draft of this report to the Commissioner of Internal
Revenue, the Secretary of the Treasury, and the Leader of Government
Business of the Cayman Islands for review and comment. IRS and the
Cayman Islands government provided technical comments, which we
incorporated as appropriate.
Background:
The Cayman Islands is a United Kingdom Overseas Territory located in
the Caribbean Sea south of Cuba and northwest of Jamaica, with a total
land area approximately 1.5 times the size of Washington, D.C., and a
population of 47,862, as seen in figure 1. While geographically small,
the Cayman Islands is a major offshore financial center (OFC) with no
direct taxes that attracts a high volume of U.S.-related financial
activity, often involving institutions rather than individuals.
[Footnote 4] According to Treasury, U.S. investors held approximately
$376 billion in Cayman-issued securities at the end of 2006, making it
the fifth largest destination for U.S. investment in foreign
securities. Although not easily defined, OFCs are generally described
as jurisdictions that have a high level of nonresident financial
activity, and may have characteristics including low or no taxes, light
and flexible regulation, and a high level of client confidentiality.
Figure 1: Cayman Islands Demographics and Financial Industry
Statistics:
[See PDF for image]
This figure contains a map of the Caribbean Islands, as well as the
following demographics and financial industry statistics:
Cayman Islands (located west of Jamaica and south of Cuba):
* United Kingdom Overseas Territory;
* Population of 47,862;
* Approximately 1.5 times the size of Washington, DC, in area;
* Over 80,000 registered companies;
* Major domicile for hedge funds, with an estimated 35 percent of funds
worldwide;
* Top foreign jurisdiction for U.S.-held asset-backed securities, at
$119 billion;
* Major international banking center, with highest level of U.S.
banking liabilities and second highest level of U.S. banking claims of
any foreign jurisdiction, as of September 2007 and June 2007,
respectively.
Source: Map resources; U.S. and Cayman Islands government, and private
industry statistics.
[End of figure]
Types of Financial Activity Conducted in the Cayman Islands:
As a major international financial center, the Cayman Islands attracts
a high volume of financial activity in sectors related to banking,
hedge-fund formation and investment, structured finance and
securitization, captive insurance, and general corporate activities.
The Cayman Islands is a major international banking center, with nearly
$2 trillion in banking assets as of December 2007, according to the
Cayman Islands Monetary Authority (CIMA), the jurisdiction's financial
regulatory agency. CIMA reports that as of March 2008, 277 banks were
licensed to operate on the island, of which 27 percent were based in
the United States. CIMA also reported that 97 percent of the $2
trillion held by these banks as of December 2007 was from institutions
rather than individual investors. [Footnote 5] Treasury statistics
indicate that, as of September 2007, U.S. banking liabilities to the
Cayman Islands were the highest of any foreign jurisdiction at nearly
$1.5 trillion, and as of June 2007, banking claims on the Cayman
Islands were the second highest (behind the United Kingdom), at $940
billion.
The Cayman Islands is also a major domicile for hedge funds. According
to CIMA, 9,018 mutual funds[Footnote 6] were registered in the Cayman
Islands in the registered funds category as of the first quarter 2008,
the vast majority of which were hedge funds. Although there is no
statutory or universally accepted definition of hedge funds, the term
is commonly used to describe pooled investment vehicles that are
privately organized and administered by professional managers and that
often engage in active trading of various types of securities and
commodity futures and options contracts. While there is no universally
accepted definition of a hedge fund, private-industry sources cited by
the Joint Committee on Taxation estimate that there were approximately
$1.5 trillion in assets managed by hedge funds worldwide as of the end
of 2006, and approximately 35 percent of funds were organized in the
Cayman Islands.[Footnote 7] Funds organized in the Cayman Islands may
be managed in the United States. According to the same source, the
United States was by far the leading location for hedge-fund managers,
who managed an estimated 65 percent of hedge-fund assets in 2006.
In addition to being a prominent domicile for hedge funds, the Cayman
Islands also carries out a high volume of structured finance activity.
While structured finance can encompass a number of financing
strategies, it often involves securitization, the process of pooling
similar types of financial assets, such as current or future cash flows
from loans, and transforming them into bonds or other debt securities.
[Footnote 8] Securitization involves isolating a group of assets to
serve as the basis of financing that is intended to be legally remote
from the bankruptcy risks of the former owner, and is generally
designed to move those assets off of the owner's balance sheets. In the
Cayman Islands, asset-backed securitization has been used widely to
turn self-liquidating assets, such as receivables from mortgages, into
debt securities that can be offered and sold on capital markets.
Treasury data show that as of the end of 2006, U.S. investors held more
asset-backed securities issued by the Cayman Islands, at about $119
billion, than asset-backed securities issued by any other foreign
jurisdiction.
The Cayman Islands is also a major domicile for the captive insurance
industry. In its basic form, captive insurance is a method by which
companies can self-insure against various types of risk rather than
purchasing insurance from an insurance company.[Footnote 9] In a
traditional arrangement, a parent company will establish a subsidiary
to act as a captive insurer. Other types of captive insurance
arrangements exist as well, such as those in which a single captive
insures, and is owned by, multiple companies. According to CIMA, the
Cayman Islands was home to 760 licensed captive insurance companies as
of April 2008, with nearly $34 billion in total assets and $7.6 billion
in premiums. Ninety percent of these companies insured risks in North
America. Slightly over a third were related to healthcare.
Lastly, a wide range of corporate-related activities are carried out in
the Cayman Islands. According to the Cayman Islands Registry of
Companies, over 80,000 companies were registered in the Cayman Islands
as of May 2008.
U.S. Persons Are Frequently Associated with Ugland House Registered
Entities:
Many of the 18,857 entities registered at Ugland House are U.S.-
connected. These entities most frequently involve investment funds and
structured finance vehicles.
Maples and Calder, an International Law Firm and Provider of Registered
Office Services, Is the Only Occupant of Ugland House:
Ugland House,shown in figure 2, is located at 301 South Church Street,
George Town, Grand Cayman, Cayman Islands. It houses the international
law firm of Maples and Calder; Maples Corporate Services Limited, a
licensed trust company owned by Maples and Calder which provides
registered office services to clients of Maples and Calder; and Maples
Finance Limited, a licensed trust company and mutual fund administrator
owned by Maples and Calder which provides fiduciary and fund
administration services.[Footnote 10] Maples business is to facilitate
Cayman Islands-based international financial and commercial activity
for a clientele of primarily international financial institutions,
institutional investors, and corporations. Maples is the only occupant
of Ugland House.
Maples provides registered office services to companies, using the
Ugland House address.[Footnote 11] A registered office[Footnote 12] is
required by Cayman Islands law for corporations registered in the
Cayman Islands. States in the United States have similar statutory
requirements. Registered office services include activities such as
accepting any service of process or notices, maintenance of certain
entity records, and filing of statutory forms, resolutions, notices,
returns, or fees. As is the case with many U.S. states' laws, Cayman
Islands law does not require or presume that any other business
activity of the corporation occurs at the registered office.
Figure 2: Ugland House:
[See PDF for image]
This figure contains a photograph of Ugland House, as well as the
following supporting text:
Ugland House:
* Sole tenant is Maples and Calder law firm, which provides registered
office services to companies established in the Cayman Islands;
* 18,857 registered entities at the Ugland House address;
- Very few have a significant physical presence in the Cayman Islands;
- Five percent wholly U.S. owned;
- Fewer than 50 percent have a U.S. billing address.
Source: GAO photograph and statistics obtained from the Cayman Islands
government and Maples.
[End of figure]
Cayman Islands law requires company service providers that establish
entities and provide registered office services to adhere to specific
Anti-Money Laundering (AML) and Know-Your-Customer (KYC) requirements.
[Footnote 13] For example, as a company service provider, Maples must
verify and keep records on the beneficial owners of entities to which
they provide services, the purpose of the entities, and the sources of
the funds involved. If suspicion arises in relation to any of these
types of inquiries, the company service provider is required to make a
suspicious activity report (SAR) to the Cayman Islands Financial
Reporting Authority (CAYFIN). Cayman Islands law allows for nominee
shareholders and the provision of officers and directors.[Footnote 14]
The use of nominees, though, does not relieve the company service
provider from its obligation under Cayman Islands law to know the
beneficial owner under AML-KYC rules. In contrast, state laws which
govern the creation of corporations in the United States generally do
not require company formation agents to collect ownership information
on the entities they register.[Footnote 15] The Cayman Islands has
taken steps to restrict the use of bearer shares to obscure ownership
or control of an entity. Use of bearer shares in the Cayman Islands is
restricted to cases where they are immobilized through deposit with an
authorized or recognized custodian who must keep a register of owners
and perform the required beneficial ownership verification.[Footnote
16]
The Ugland House Address Was Used by 18,857 Entities as of March 2008,
and Very Few of These Have a Significant Physical Presence in the
Cayman Islands.
According to the Cayman Islands Registrar, as of March 6, 2008, 18,857
active entities used Ugland House as a registered office, and based on
the nature of these entities very few have a significant physical
presence in the Cayman Islands. As displayed in figure 3, approximately
96 percent of Ugland House entities are exempt companies, exempt
limited partnerships, and exempt trusts.[Footnote 17] Exempted
companies are prohibited from trading in the Cayman Islands with any
person, firm, or other corporation except in furtherance of their
business that is carried on outside the Cayman Islands. Exempted
limited partnerships exist under the same criteria and must have at
least one general partner that is resident or incorporated in the
Cayman Islands. Requirements for exempt trusts are that they must
register with the Cayman Islands Registrar and have no beneficiary that
is domiciled in or resident of the Cayman Islands. A Maples and Calder
partner indicated that some exempted companies occasionally maintain
minimal sales or marketing staff in the Cayman Islands to facilitate
business conducted elsewhere, but most have no staff or facilities in
the Cayman Islands and none, except for Maples group companies, is run
out of Ugland House. According to Cayman Islands government officials,
the domestic trading prohibition on exempted companies and exempted
limited partnerships, is intended to protect the small domestic market
from being flooded by outside competitors. Thus, exempted entities that
wish to trade in the local market must receive a special license to do
so under the Local Companies (Control) Law.
Figure 3: Ugland House Entities by Type, March 2008:
[See PDF for image]
This figure is a pie-chart depicting the following data:
Ugland House Entities by Type, March 2008:
Exempted companies: 15,130 (80%);
Exempted limited partnerships: 2,738 (15%);
Foreign companies: 636 (3%);
Exempted trusts: 161 (1%);
Non-resident companies: 115 (1%);
Resident companies: 77 (0%).
Source: GAO presentation of Cayman Islands Registrar information.
[End of figure]
According to Cayman Islands Companies Law, nonresident companies are a
category of entity similar to an exempted entity in that neither can
conduct business in the Cayman Islands. Foreign companies are organized
under the laws of a jurisdiction other than the Cayman Islands, but
have chosen to register with the Cayman Islands Registrar to conduct
business in the Cayman Islands, such as to become a general partner in
a Cayman Islands exempted limited partnership. Finally, less than 1
percent of Ugland House entities are "resident" companies that are
registered to conduct their business in the Cayman Islands. According
to a Maples and Calder partner, the persons establishing entities at
Ugland House are typically referred to Maples by counsel from outside
the Cayman Islands, fund managers, and investment banks. A Maples and
Calder partner also said that the make-up of entities in Ugland House
was reflective of the nature of their business and largely
international, institutional client base, and was not necessarily
representative of the types of entities registered with other company
service providers in the Cayman Islands.
Ugland House Registered Entities Often Involve Investment and
Structured Finance Business:
According to Maples and Calder partners, their business primarily
involves two areas: investment funds and structured finance. [Footnote
18] Specifically, they estimated that approximately 38 percent of the
Cayman Islands companies and limited partnerships that have a
registered office at Ugland House are formed to act as various types of
hedge funds or private-equity funds[Footnote 19] (together referred to
as "investment funds"), and generally involve institutional and high
net-worth investors. Approximately 24 percent of entities formed
related to structured finance/capital markets and project finance
business, such as securitization or aircraft finance, and 38 percent
are of a "general corporate" nature. The general corporate business was
described as being a "catch-all" category that may involve some overlap
with the other two areas of entity formation. Maples and Calder
partners explained that their general corporate business involves
entities such as trading companies, joint ventures, holding companies,
wholly owned subsidiaries, and captive insurance companies.
To obtain a more detailed understanding of Maples business, we reviewed
a total of 133 instances of new business instructions that could have
led to the formation of a Cayman Islands entity. These contacts
occurred over a period of 2 separate weeks in December 2007 and March
2008. We found that approximately 74 percent of all instructions
involved investment-fund-related business. Approximately 17 percent of
the instructions involved general corporate business, and approximately
11 percent involved structured finance business. While this business
distribution is somewhat different than what Maples and Calder partners
estimated, the activity undertaken in these 2 weeks may not be
representative of Maples' registered office business as a whole. Maples
and Calder partners commented that activity in the weeks that we
reviewed may reflect the recent decline in structured finance work
caused by the "credit crunch."
Five Percent of the Entities Registered at Ugland House Are Wholly
Owned by U.S. Persons and Fewer than 50 Percent Are U.S.-Related:
Maples and Calder partners estimated that 5 percent of the overall
number of Ugland House entities are wholly owned by U.S. persons.
[Footnote 20] The partners also said that fewer than 50 percent, likely
in the 40 to 50 percent range, of all Ugland House entities are U.S.-
related in that their billing address is in the United States. This
distribution of relationships is due to the nature of the entities
registered in Ugland House.
Other than for those entities which are wholly owned or controlled, the
concepts of ownership and control are complex for most of the entities
registered in Ugland House. According to the partners, because a
significant amount of Maples' registered entities are related to
structured finance or investment fund transactions, direct ownership or
control by a U.S. person is only representative of a small number of
entities registered at Ugland House. For example, structured finance
entities are not typically carried on a company's balance sheet, and
ownership can be through a party other than the person directing the
establishment of the entity, such as a charitable trust, or spread
across many noteholders or investors in deals involving securitization.
U.S. persons' involvement with structured finance entities is therefore
of a different nature, and may include arranging or participating in
deals without clear U.S. ownership or control. Similarly, while
investment fund entities are often established, controlled, and managed
at the direction of investment managers, such entities are generally
established as partnerships and are essentially owned by the fund's
investors. In addition, one investment fund or structured finance
transaction can involve more than a dozen separate legal entities,
thereby increasing the number and complexity of relationships involved.
For those instances for which Maples and Calder has a U.S. billing
address for an Ugland House entity, U.S. involvement often takes the
form of providing services to Cayman Islands entities, as opposed to
wholly owning or controlling the entity. For example, the partners
explained that many of the recipients of invoices include U.S.
investment banks, paying agents, securities trustees, law firms,
placement agents, and administrators for private-equity funds and hedge
funds. The partners gave as an example of a tenuous connection a
situation where a U.S. bank was the billing address for an Ugland House
registered entity established for a Brazilian company to raise funds
within Brazil for a Brazilian project.
New business instructions received by Maples that we reviewed provided
additional detail regarding the type and role of U.S. persons involved.
Among these instructions, approximately 60 percent involved U.S.
persons, mostly through managerial, promoter, or advisory roles. Four
percent involved U.S. subsidiaries or holding companies. U.S.
investment firms were involved in approximately 44 percent of the
transactions we reviewed, generally in the role of investment advisor,
manager, or promoter. U.S. companies and banks were the second most
common type of U.S. persons involved, with U.S. banks frequently
directing the establishment of investment-related entities. U.S.
persons were participants in a joint venture or were partners in a
transaction in approximately 5 percent of the instructions. Maples and
Calder partners said that major onshore commercial law firms or in-
house legal counsel instruct Maples to form the entities, although we
could not verify this in the new business instructions that we
reviewed. The partners also said that onshore lawyers advise their
clients on all onshore legal, regulatory, and tax issues for their home
jurisdictions.
Ugland House Investment Entities Are Hedge and Private-Equity Funds,
And U.S. Investors Are Largely Institutional, such as University
Endowments and Pension Funds:
The Cayman Islands is a major domicile for global hedge funds. Maples
investment funds business is largely hedge-fund related, and also
includes private-equity funds. Maples said that their investment fund
clients are predominantly large investment banks or investment
management firms, or the funds arranged by such firms for institutional
and high-net-worth investors. Documentation provided by Maples
indicated that persons establishing and investing in investment funds
included investment banks, pension funds, insurance companies, and
university endowments. According to Maples and Calder partners, Cayman
Islands funds are used to facilitate significant investment in the
United States by non-U.S. investors. They said that one reason that
many non-U.S. investors prefer not to invest directly into the United
States is because of perceived litigation risk, and that the ability of
U.S. fund managers to manage Cayman Islands funds, therefore, helps
U.S. fund managers compete globally.
An understanding of the structure and function of hedge funds and
private-equity funds provides additional insight into the nature of the
entities registered at Ugland House. Hedge funds are private investment
funds that are actively traded by a fund manager. Hedge funds are "open
ended," in that investors are generally allowed to invest additional
money or redeem shares at designated dates. Maples explained that hedge
funds often are composed of a "master-feeder" structure wherein
"feeder" fund entities are established that receive subscriptions from
different investor groups and invest in a "master fund" entity. The
master fund entity is established for holding assets and making
investment instructions. In this way, economies of scale can be
maximized while allowing for simplified trading and reconciliation of
portfolios of the assets invested. According to Maples, when U.S.
investors invest in offshore funds in the Cayman Islands, they
typically prefer doing so through a "feeder" entity that is formed in a
U.S. state such as Delaware. Figure 4 displays a common "master-feeder"
hedge-fund structure. As figure 4 depicts, the fund is managed and
administered, and fund managers can be U.S. persons. Also, Maples and
Calder partners stated that U.S. and non-U.S. brokers/custodians offer
services such as centralized securities and trade execution for the
fund.
Figure 4: U.S. Persons' Involvement in Cayman Master-Feeder Hedge Fund
Structure:
[See PDF for image]
This figure is an illustration of U.S. persons' involvement in the
Cayman Master-Feeder Hedge Fund Structure, as follows:
U.S. taxable investors (area of identified U.S. involvement):
Transaction: Pays for shares to Delaware LP/LLC (feeder fund) and is
issued shares.
Non-U.S. investors and U.S. tax exempt investors (area of identified
U.S. involvement):
Transaction: Pays for shares to Cayman company (feeder fund) (Ugland
House registered entity) and is issued shares.
Non-U.S. investors:
Transaction: Pays for shares to Cayman unit trust (feeder fund) (Ugland
House registered entity) and is issued shares.
With all of the above:
Cayman company/partnership (Master fund) (Ugland House registered
entity) issues shares and received payment for shares;
Investment fund administrator administers the fund;
Investment fund manager manages the fund;
Non-U.S. broker/custodian holds assets for the master fund;
U.S. prime broker (area of identified U.S. involvement) executes trades
and holds assets for the master fund.
Source: GAO presentation of Maples and Calder information.
[End of figure]
The other type of investment entities registered at Ugland House are
private-equity funds. In contrast to hedge funds, private-equity funds
are generally private funds involving long-term, "closed" investments
that do not involve an actively traded portfolio of stocks. Private-
equity funds typically make 7-to10-year concentrated investments in a
company and often seek to create value by providing management support
or consulting services to the portfolio companies. According to
officials from OPIC,[Footnote 21] one-third to half of private-equity
funds in which it has invested have been organized in the Cayman
Islands. According to Maples and Calder, private-equity funds are
usually formed as limited partnerships rather than as corporations.
Ugland House Structured Finance Entities Are Largely Off-Balance-Sheet
Special Purpose Vehicles Involving Securitization, Asset Transfer, or
Risk Isolation:
Structured finance entities are companies that are formed for a
specific and, in some cases, finite purpose. Commonly referred to as
Special Purpose Entities (SPEs) or Special Purpose Vehicles (SPVs),
[Footnote 22] these companies can be used in many different types of
business transactions. Maples and Calder partners told us that
structured finance entities using Ugland House as a registered office
are largely related to transactions such as securitization, aircraft
finance, and other deals involving isolating risk and raising capital.
In the case of SPVs, these transactions generally involve an SPV
holding assets of some type, with the SPV being isolated from the
bankruptcy risks of the former owner of the assets--typically the
"sponsor" of the SPV. Because of this feature of SPVs, they are not
generally represented on the sponsor's balance sheet. According to a
2007 CFATF evaluation, interest in SPVs in the Cayman Islands has
increased in the 2 years prior to the reports issuance. Maples and
Calder partners stated that their clients for these types of entities
are often large investment banks and institutions, including many well-
known multinational companies.
Maples and Calder partners reported that part of their structured
finance business involves Structured Investment Vehicles (SIVs), which
are SPVs that use structured investments to make a profit from the
difference between short-term borrowing and longer-term returns. Unlike
some SPVs, SIVs can be established to continue their operations for an
indefinite period. SIVs often invest in structured finance products
such as asset-backed securities, which include bonds backed by auto
loans, student loans, credit card receivables, and mortgage-backed
securities. These structures are also used to facilitate major capital
inflows from foreign investors into the United States, according to
Maples. SIV use in the Cayman Islands originated as the use of
structured finance techniques evolved in financial markets, with the
first Cayman SIV launched in 1988. These financial instruments received
heightened interest following the financial market crisis in 2007 after
problems surfaced related to bank-sponsored SIVs.
As shown in figure 5, SIVs are sponsored by an institution, such as a
bank, and an investment manager is appointed to provide investment
advice together with funding and operational support. In addition, the
SIV can be underwritten and arranged by an investment bank. As figure 5
depicts, the SIV sponsor, investment manager and underwriter/arranger
can be U.S. persons. The SIV sells notes to investors through a
clearinghouse, and investors are paid interest through a trustee and
paying agent. Finally, a swap counterparty can enable additional
investors to participate in the SIV in a different currency and
interest rate than the underlying asset being financed. Figure 5 shows
that SIV investors, trustee and paying agents, and swap counterparties
can also be U.S. persons.
Figure 5: U.S. Persons' Involvement in Cayman Structured Investment
Vehicles:
[See PDF for image]
This figure is an illustration of U.S. persons' involvement in Cayman
Structured Investment Vehicles, as follows:
Investment bank (Underwriter/arranger) (area of identified U.S.
involvement):
* Underwrites notes, arranges transactions to Cayman Company (Issuer)
(Ugland House registered entity);
* Received fees from Cayman Company (Issuer).
Originator/sponsor (area of identified U.S. involvement):
* Transfers assets to Cayman Company (Issuer);
Received payment for assets from Cayman Company (Issuer).
Maples Finance Limited (Directors, share trustees, administrator):
* Provides directors and share trustees to Cayman Company (Issuer).
Investment/collateral manager (area of identified U.S. involvement):
* Receives fees from Cayman Company (Issuer);
* Manages portfolio for Cayman Company (Issuer);
* Pays income to Trustee and paying agent (area of identified U.S.
involvement).
Trustee and paying agent (area of identified U.S. involvement):
* Pays interest to Investors (area of identified U.S. involvement);
* Swaps payment with Swap counterparty (area of identified U.S.
involvement).
Investors (area of identified U.S. involvement):
* Pays for notes and sells notes to Cayman Company (Issuer) through a
Clearinghouse.
Source: GAO presentation of Maples and Calder information.
[End of figure]
A second type of Maples SPV activity includes transactions involving
asset transfer, such as aircraft leasing deals. Maples and Calder
partners explained that aircraft financing deals using Ugland House
registered structured finance vehicles have involved Boeing, a U.S.
airplane manufacturer, as well as a non-U.S. aircraft manufacturer. As
shown in figure 6, these deals involve the creation of an SPV whose
shares are owned by a Cayman Islands charitable trust, and managed by a
company service provider such as Maples Finance Limited. Aircraft
involved in the deal are sold by the aircraft manufacturer to the SPV,
which then leases the aircraft to the party that will operate the
aircraft, such as a government or private entity from another country.
The whole transaction is arranged by a third-party financial
institution that backs the deal. Over time, the operator of the
aircraft makes payments to the SPV while using the aircraft, and within
approximately 5-8 years the aircraft are effectively paid for and the
titles are transferred from the SPV to the aircraft operator. This
structure reduces the credit risk involved and enhances the ability of
financiers to repossess the aircraft if default occurs.
Figure 6: U.S. Persons' Involvement in Cayman Aircraft Financing
Special Purpose Vehicles:
[See PDF for image]
This figure is an illustration of U.S. Persons' involvement in Cayman
Aircraft Financing Special Purpose Vehicles, as follows:
Ex-Im Bank (Arranger) (area of identified U.S. involvement):
* Advises and arranges deal with Aircraft manufacturer (area of
identified U.S. involvement);
* Guarantees loan to Syndicate of banks (lender) (area of identified
U.S. involvement).
Aircraft manufacturer (area of identified U.S. involvement):
* Sells aircraft to Caymans company (Lessor) (Ugland House registered
entity);
* Receives payment for aircraft from Caymans company (Lessor) (Ugland
House registered entity).
Operator of aircraft (lessee):
* Leases aircraft over time from Caymans company (Lessor);
* Makes lease payments to Caymans company (Lessor).
Maples Finance Limited (Directors, share trustee, and local
administrator):
* Administers and manages company for Caymans company (Lessor);
* Provides trustees to Caymans charitable trust (Ugland House
registered entity).
Caymans charitable trust:
* owns Caymans company (Lessor).
Syndicate of banks (Lender) (area of identified U.S. involvement):
* loans funds through a security agent/trustee to Caymans company
(Lessor);
* received loan repayment from Caymans company (Lessor) through a
security agent/trustee.
Source: GAO presentation of Maples and Calder information.
[End of figure]
Maples and Calder partners said that the Ex-Im Bank had facilitated
aircraft sales involving SPVs registered at the Ugland House address.
Ex-Im officials confirmed that it has been involved in supporting 42
aircraft financing deals involving the Cayman Islands since 2003, with
24 entities involving Maples as counsel. Ex-Im Bank officials reported
that one nonaircraft deal had been conducted involving the Cayman
Islands, and that Maples served as counsel to the borrower in that
deal. They said that since 2006 there has been less frequent use of
Cayman Islands entities in U.S. aircraft financing deals since the
United States ratified the Cape Town Treaty in 2006. That treaty
established common international protocols and standards for cross-
border aircraft financing and leasing. The United Kingdom has not
signed this agreement, and as a United Kingdom overseas territory, the
Cayman Islands therefore is not party to the agreement. Ex-Im Bank
officials said that many structured finance deals involving the lease
of U.S. aircraft now utilize other jurisdictions governed by the
treaty, such as Delaware.
Other Ugland-Registered Entities Include Corporate Subsidiaries,
Holding Companies, and Trusts:
In addition to investment funds and structured finance entities, Maples
provides registered office services to general corporate entities such
as corporate subsidiaries and holding companies. Maples also
establishes trusts, and a portion of those choose to be registered.
Maples and Calder partners reported that a limited number of their
general corporate entities are wholly owned subsidiaries of
multinational corporations. Examples of this type of entity with a U.S.
connection identified from Maples' new business instructions that we
reviewed include:
* Formation of a company to be a subsidiary of a U.S. company to
provide film production services for a film being shot in Romania.
* Formation of a company by a U.S.-based company for the purposes of
providing information technology services in Asia.
According to Maples and Calder partners, Cayman Islands holding
companies often have been used by businesses in emerging market
countries to conduct initial public offerings of shares listed in the
United States or Europe.
Captive insurance companies are also contained within this general
corporate category of Maples' business, although the number of captive
insurance entities registered at Ugland House is relatively low due to
the Cayman Islands requirement for captive insurance companies to have
a licensed insurance manager located within the Cayman Islands. For
this reason, captive insurance companies in the Cayman Islands
frequently use the insurance manager's location as their registered
office address.
A portion of Maples general corporate business involves the
establishment of holding companies. Examples of this type of entity
with a U.S. connection that we identified from new business
instructions that we reviewed include:
* Formation of an intermediate holding company for a company listed on
the New York Stock Exchange with operations in 30 countries.
* Formation of an investment holding company for the Hong Kong arm of a
Wall Street bank.
* Formation of two investment holding companies for real estate
investments in Eastern Europe to be owned by a private-equity fund
managed by a U.S. private-equity fund manager.
Maples and Calder partners said that the formation of holding companies
typically involves intermediate limited liability holding companies
formed by multinational corporations to isolate risk related to their
foreign assets. They said that the formation of personal holding
companies was increasingly rare. They also indicated that the holding
companies that they typically establish involve the company existing at
the bottom of a family of corporate structures to hold specific assets,
rather than at the top of the pyramid of the corporate family. As the
example cases above describe, some holding companies established by
Maples are associated with private-equity funds.
Lastly, Maples establishes trusts for clients, some of whom choose to
be registered as exempted trusts under Cayman Islands law. Exempted
trusts afford official confirmation in the form of a certificate that
the trust will remain exempt from any potential future direct taxes
that may be imposed by the Cayman Islands for a specified period of
time of up to 50 years. Such certificates are regarded in the market as
reflecting the stable status quo as well as providing an additional
level of commercial certainty.[Footnote 23] A senior Maples and Calder
partner said that the clients for their trust business are invariably
institutional trustees rather than the settlers of trusts, and mainly
consist of banks (U.S. and non-U.S.) serving as trustees for non-U.S.
taxpayers in private wealth trusts. He stated that a portion of Maples
trust business involves private wealth management, and that wealthy
individuals in Central and South America and the Middle East establish
trusts in other nations such as the Cayman Islands to manage their
wealth primarily because their home jurisdictions have no structure
equivalent to a trust due to their not having a common law tradition.
According to Maples and Calder partners, being able to offer Cayman
Islands trusts enables major U.S. banks to compete with other major
foreign banks for private wealth management and lending business.
Because the United States has trusts, U.S. persons rarely seek to
establish trusts in the Cayman Islands, according to Maples and Calder
partners. Maples and Calder partners also noted that U.S. states such
as Delaware tend to service the domestic U.S. trust business. They said
that, in addition to private wealth trusts, commercial trusts are
sometimes established for Japanese clients as well.
Several Factors Influence U.S. Taxpayers' Decisions to Conduct
Financial Activity in the Cayman Islands:
U.S. persons who engage in Cayman-based financial activity commonly do
so to gain business advantages, including tax advantages under U.S.
law. Although such activity is typically legal, some persons have
engaged in activity in the Cayman Islands, like other jurisdictions, in
an attempt to avoid detection and prosecution of illegal activity by
U.S. authorities.
While OFCs Generally Offer Tax Benefits, U.S. Persons May Choose to
Conduct Financial Activity in the Cayman Islands for a Number of
Additional Reasons:
While the Cayman Islands is one of a number of OFCs that attract
substantial financial activity from the United States due to tax and
other benefits, the Cayman Islands offers a combination of additional
factors that may draw U.S. activity. In particular, the Cayman Islands
is generally regarded as having a stable and internationally compliant
legal and regulatory system, a business-friendly regulatory
environment, and a reputation as a prominent international financial
center.
First, because the Cayman Islands' legal and regulatory system is
generally regarded as stable and compliant with international
standards, U.S. persons looking for a safe jurisdiction in which to
place funds and assets may choose to carry out financial transactions
there. In particular, Cayman Islands law is based on English common
law, which is familiar in the United States due to similarities between
British and U.S. legal systems. The Cayman Islands regulatory regime
has also been deemed by the International Monetary Fund to be well-
developed and in compliance with a wide range of international
standards. Pursuant to a 2007 on-site evaluation, the Caribbean
Financial Action Task Force (CFATF) also cited the Cayman Islands as
having a strong compliance culture related to anti-money laundering and
terrorist-financing activities. IRS officials cited the Cayman Islands'
reputation for regulatory sophistication as a potential factor in
attracting legal financial activity from the United States.[Footnote
24]
U.S. persons may also be drawn to the Cayman Islands because of its
business-friendly regulatory environment. Establishing a Cayman Islands
entity can be relatively inexpensive. For instance, an exempted company
can be created for less than $600 U.S., not taking into account service-
providers' fees, and it is not required to maintain its register of
shareholders in the Cayman Islands or hold an annual shareholder
meeting. Additionally, Cayman government officials noted that the
jurisdiction has a public-private sector cooperative approach to
regulation and attempts to be responsive to the needs of market
participants. For instance, Cayman law requires CIMA to consult with
the private sector prior to issuing or amending rules.[Footnote 25] The
jurisdiction's responsiveness to market needs led it to adopt the
Segregated Portfolio Company (SPC), a type of entity that opened up the
captive insurance industry to smaller companies unable to meet minimum
reserve levels on their own, but capable of doing so in groups. The
Cayman Islands may also attract U.S.-related captive insurance
companies because it has lower capital requirements than some U.S.
states.
Additionally, as reported by Maples and Calder attorneys and U.S.
officials, some persons may be attracted to the Cayman Islands to take
advantage of specific legal protections for creditors and investors.
According to Maples and Calder attorneys, if a Cayman Islands fund or
other entity becomes insolvent, Cayman law is generally focused on
protecting the interests of creditors and investors. For example,
according to Maples and Calder, Cayman law differs from U.S. bankruptcy
law in that it provides no moratoria on secured-creditor action against
a debtor company. Officials from OPIC report that, as an investor, it
is important to OPIC that private-equity funds it invests in be
organized in a jurisdiction with strong legal protections for
creditors, such as the Cayman Islands. According to them, nearly half
of the funds with which OPIC has been involved were organized in the
Cayman Islands. Similarly, officials from the Ex-Im Bank stated that
Cayman Islands law gives them confidence that they will have less
difficulty reclaiming assets if a party in an Ex-Im-backed transaction
defaults.
The Cayman Islands may also be a jurisdiction of choice among U.S.
persons due to factors related to its location and reputation for
prominence as an international financial center. The Cayman Islands is
proximate to the United States, operates in the same time zone as New
York and the eastern United States and is English speaking, all factors
that may contribute to U.S. persons' choices to conduct activity there.
It has a robust financial services sector, which includes several major
law firms and other locally based service providers, as well as
prominent international accounting and audit firms, fund
administrators, and banking institutions. The high volume of existing
Cayman-based financial activity may also be responsible for drawing
additional business. For instance, relationships between U.S. and
Cayman law firms and other service providers may result in referrals of
additional business.
Finally, U.S. persons may carry out activity in the Cayman Islands
because of its reputation as a neutral jurisdiction for structuring
deals with foreign partners. Ex-Im Bank officials explained that they
frequently created Cayman Islands entities to facilitate the purchase
of U.S. aircraft, and these deals often involve foreign entities who
may prefer not to carry out business in the United States for tax,
regulatory, or political reasons. Additionally, OPIC officials stated
that foreign investors in private-equity funds that they are involved
with value the Cayman Islands' reputation for legal neutrality towards
investors from different jurisdictions.
Some U.S. Persons Can Defer or Minimize Tax by Carrying Out Financial
Activity in the Cayman Islands:
Some U.S. persons engaging in financial activity in the Cayman Islands
are able to legally minimize their U.S. tax obligations. For instance,
some U.S. persons can minimize their U.S. tax obligations by using
Cayman Islands entities to defer U.S. taxes on foreign income. In
general, the United States taxes U.S. persons, including corporations,
on their worldwide income,[Footnote 26] but only taxes foreign
corporations on their U.S. income. The United States does not tax U.S.
shareholders of corporations, whether foreign or domestic, until the
corporation makes a distribution to the shareholder, unless an
exception applies, such as when the foreign corporation is a controlled
foreign corporation and earns certain types of income. If a U.S. person
earns foreign income, he is taxed on that income; however, if a U.S.
person is a shareholder of a foreign corporation and that corporation
earns foreign income, then, in general, the United States will not tax
that income until it is distributed to the U.S. shareholder. In this
way a U.S. taxpayer may be able to defer taxes on some foreign income.
For example, a U.S.-based multinational business with a Cayman Islands
subsidiary earning foreign income may be able to defer U.S. taxes on
that foreign income. The income deferred is not limited to income
earned in the jurisdiction of incorporation but can be any non-U.S.
income. If the foreign income had been earned by a U.S. component of
the multinational, U.S. taxes would be owed when that income was
earned. Instead, by employing a Cayman Islands subsidiary U.S. taxes
are owed when the Cayman Islands subsidiary makes a distribution to the
parent.
In some instances, U.S.-based parent corporations may be able to defer
taxes on foreign-source income from foreign subsidiaries indefinitely
by reinvesting that income overseas. Additionally, U.S. parent
corporations may further reduce U.S. taxes on foreign income by waiting
to bring the income into the United States until a period in which they
have domestic losses. Since corporate income tax is based on profits
the parent would only owe tax on repatriated income that exceeded its
domestic losses.
The Internal Revenue Code has provisions limiting this deferment in
certain circumstances. For example, if a foreign corporation qualifies
as a controlled foreign corporation, then certain U.S. shareholders
will not be able to defer tax on certain types of income, known as
Subpart F income, earned by that foreign corporation.[Footnote 27]
In other cases, persons may conduct financial activity in jurisdictions
without a corporate income tax like the Cayman Islands to avoid entity-
level tax. In general, a foreign corporation's earnings are taxed where
earned, in the entity's jurisdiction of incorporation, or both,
depending on the tax laws of the jurisdiction. Since the Cayman Islands
has no direct taxes, a corporation organized there will not owe taxes
to the Cayman Islands government. For instance, foreign hedge funds
sponsored by U.S.-based managers are also generally organized as
corporations in tax-neutral jurisdictions like the Cayman Islands to
avoid double taxation for foreign investors. Officials we spoke with
from the Ex-Im Bank also indicated that one motivation for structuring
aircraft-financing leases in the Cayman Islands was the lack of entity-
level tax on the entities established to hold the aircraft during the
period of the lease.
One indication of the extent to which U.S. companies use Cayman Islands
entities to defer taxes is their reaction to a recent tax law. In 2004,
Congress approved a received dividend deduction for certain earnings of
foreign subsidiaries of U.S. companies repatriated for a limited time.
[Footnote 28] Approximately 5.5 percent of the nearly $362 billion
repatriated between 2004 and 2006 was from Cayman Islands controlled
foreign corporations. The Cayman Islands ranked eighth among all
countries in the amount of repatriated income.
Another way U.S. persons may use Cayman Islands entities to reduce U.S.
tax obligations is to receive investment income in a form that avoids
the unrelated business income tax (UBIT). The investment income of U.S.
tax-exempt entities, including pension funds, charitable trusts,
foundations, and endowments, can be subject to UBIT if it is earned by
a U.S. partnership in which the tax-exempt entity is a partner. Many
U.S. investment vehicles, such as hedge funds, are organized as limited
partnerships because, unlike U.S. corporations, these entities are not
generally separately taxed, and as a result, income is only taxed at
the level of individual investors. Tax-exempt entities that invest in
hedge funds organized as foreign corporations can be paid in dividends,
which are not subject to UBIT. If an investment fund is incorporated in
a jurisdiction without a corporate income tax, such as the Cayman
Islands, the fund's returns will not be subject to corporate income
tax. According to the SEC, the growth in hedge funds has been largely
driven by increased investment on the part of U.S. tax-exempt entities.
Some U.S. persons may also aggressively interpret U.S. tax law. The
U.S. Internal Revenue Code is highly complex, and new strategies to
reduce U.S. taxes continue to emerge as business environments change
and in response to new rules and guidance. As we have reported before,
some have postulated that major corporations' tax returns are actually
just the opening bid in an extended negotiation with IRS to determine a
corporation's tax liability.[Footnote 29]
In some cases, new tax-avoidance practices may emerge that involve
complex legal issues. For instance, IRS is examining a strategy used by
offshore hedge funds to avoid unfavorable tax consequences of owning
U.S. stocks directly. Because many hedge funds are organized in tax-
free jurisdictions like the Cayman Islands that do not have income-tax
treaties with the United States, investors in these funds are generally
subject to full 30 percent withholding rates on certain earnings from
U.S. investments such as dividends. However, some hedge funds may have
avoided these withholding taxes on dividends by selling their U.S.
stocks to a U.S.-based derivatives dealer prior to a dividend payout in
exchange for a payment equivalent to the value of the dividend, and
then repurchasing the stocks after the payout.
Specific tax positions may require complex legal and economic analysis
to determine their legality. In particular, transfer pricing by
multinational enterprises can pose challenges for IRS and U.S.
regulators. IRS officials said that U.S. persons use entities
established in many low-tax jurisdictions for transfer-pricing
purposes. They also reported that they have dealt with transfer-pricing
issues involving Cayman Islands entities, but that the problem is not
worse there than in other jurisdictions.
While the Internal Revenue Code and Treasury regulations state that
transfer prices between related parties must be consistent with
transfer prices that would be charged between unrelated parties, some
taxpayers may manipulate these prices to obtain favorable tax outcomes
in the related context. Additionally, because multinational operations
and transactions can be quite complex and pricing methods may be
inexact, evaluating the appropriateness of particular transfer prices
can be difficult. A recent Treasury report delineates a number of areas
in which taxpayers take advantage of ambiguities in rules and legal
guidance, aggressively setting transfer prices to move profits offshore
and thereby avoid U.S. taxes.[Footnote 30] In particular, the report
found that two types of activities among related parties--cost-sharing
arrangements and services transactions--were key sources of transfer-
pricing abuse.[Footnote 31] Further, while Treasury urges caution in
interpreting specific aspects of its findings, a recent working paper
by Treasury's Office of Tax Analysis finds that data are consistent
with, although not proof of, the existence of potential income shifting
from inappropriate transfer pricing.
Despite Cayman Regulatory Safeguards, Some U.S. Persons Conduct
Financial Activity in the Cayman Islands to Hide Illegal Activity from
U.S. Authorities:
As with other foreign jurisdictions and OFCs, some persons have
conducted financial activity in the Cayman Islands in an attempt to
avoid discovery and prosecution of illegal activity by the United
States. As discussed later in this report, in 45 instances over the
past 5 years IRS field agents have requested information from the IRS
official responsible for the Caribbean about potential criminal
activity on the part of U.S. persons in the Cayman Islands.
Additionally, as we further explore later in this report, our review of
21 criminal and civil cases including those referred to us by DOJ, SEC,
and IRS shows that U.S. persons have been involved in civil lawsuits
and come under criminal investigation for suspected offenses including
tax evasion, money laundering, and securities fraud. The full extent of
illegal offshore financial activity is unknown, but risk factors
include limited transparency related to foreign transactions,[Footnote
32] and difficulties faced by the U.S. in successfully prosecuting
foreign criminal activity. Still, as we state later in this report, IRS
officials said that criminal activity was comparatively lower in the
Cayman Islands than in some other offshore jurisdictions.
Although not unique to the Cayman Islands, limited transparency
regarding U.S. persons' financial activities in foreign jurisdictions
contributes to the risk that some persons may use offshore entities to
hide illegal activity from U.S. regulators and enforcement officials.
Voluntary compliance with U.S. tax obligations is substantially lower
when income is not subject to withholding or third-party-reporting
requirements. Because U.S.-related financial activity carried out in
foreign jurisdictions is not subject to these requirements in many
cases, persons who intend to evade U.S. taxes are better able to avoid
detection. As an example, foreign corporations established in the
Cayman Islands and elsewhere with no trade or business in the United
States are not generally required to report dividend payments to
shareholders, even if those payments go to U.S. taxpayers. Therefore, a
U.S. shareholder could fail to report the dividend payment with little
chance of detection by IRS. Persons intent on illegally evading U.S.
taxes may be more likely to carry out financial activity in
jurisdictions with no direct taxes, such as the Cayman Islands, because
income associated with that activity will not be taxed within those
jurisdictions.
Some U.S. persons have also taken steps to complicate efforts to
identify U.S. involvement in illegal activity by structuring their
activities in offshore jurisdictions. As with other OFCs, some U.S.
persons may create complex networks of domestic and offshore entities
in order to obscure their role in illegal schemes. For instance, the
defendants in United States v. Taylor and United States v. Petersen
pled guilty in U.S. District Court to crimes related to an illegal tax
evasion scheme involving offshore entities, including Cayman Islands
entities.[Footnote 33] As part of the scheme, the defendants
participated in establishing a "web" of both domestic and offshore
entities which were used to conceal the beneficial owners of assets,
and to conduct fictitious business activity that created false tax
losses, and thus false tax deductions, for clients.
Additionally, because offshore entities such as SPVs can be used to
achieve a wide array of purposes, they can be abused even when the
entities, the parties involved, and the stated business purposes pass
scrutiny at the time of establishment. For instance Enron, a global
energy company had 441 entities in the Cayman Islands in the year that
it filed for bankruptcy. Maples and Calder partners said they created
entities for Enron at the instruction of major U.S. law firms. The
partners noted that Enron's legitimate business activity often involved
holding assets in offshore subsidiaries, including many in the Cayman
Islands. However, Enron did use structured-finance transactions to
create misleading accounting and tax outcomes and deceive investors.
Maples and Calder partners said they conducted due diligence on
investment-fund managers and persons establishing structured-finance
entities in accordance with AML/KYC standards, and that they had filed
a SAR with regard to suspected illegal activity by Enron. Maples and
Calder partners also said that the accounting fraud perpetrated by
Enron was not intrinsically offshore in nature; rather, it was
committed from within the United States, and that no suggestion of
violation of either Cayman Islands law or U.S. law was ever raised with
respect to Maples and Calder.
The difficulty that U.S. regulators and law-enforcement officials face
in investigating and litigating cases may also influence U.S. persons'
choice to conduct illegal activity in offshore jurisdictions. As we
have reported, obtaining information on U.S. persons' financial
activities abroad can be time-intensive for IRS, due to issues
including difficulty accessing beneficial-ownership information.
[Footnote 34] Additionally, offshore related cases may be time-
consuming to litigate. For example, Treasury reports that IRS spends
substantial resources to litigate cases involving transfer-pricing
abuse by taxpayers. IRS confirms that transfer-pricing cases involve
entities established in the Cayman Islands and elsewhere. Transfer-
pricing cases can be very time-intensive to litigate because of the
highly specialized issues involved, and the results may provide limited
guidance for subsequent litigation of transfer-pricing issues due to
the unique sets of facts and circumstances involved in each case.
The U.S. Government Has Access to Several Information Sources Regarding
U.S. Taxpayers' Business Activities in the Cayman Islands, but Most
Information Is Self-Reported:
Individual U.S. taxpayers and corporations generally are required to
self-report their taxable income to IRS. Similarly, publicly owned
corporations traded on U.S. markets are required to file annual or
quarterly statements with SEC. When an individual or corporation
conducts business in the Cayman Islands, there is often no third-party
reporting of transactions, so the accuracy of the disclosures to U.S.
regulators is dependent on the accuracy and completeness of the self-
disclosure. When the U.S. government needs to obtain information from
the Cayman Islands, there are formal information-sharing agreements in
place to facilitate the exchange of information, in the form of a TIEA
or MLAT. In addition, both the U.S. and Cayman Islands governments
share information through their respective financial intelligence
units. There are also channels for various agencies of each government
to share intelligence.
Although U.S. Taxpayers Report Some Cayman Islands Activities to U.S.
Regulators, Overall Information Reporting Is Limited:
IRS and SEC collect self-reported information from individuals and
corporations with activity in the Cayman Islands. IRS collects
information on the number of controlled foreign corporations,[Footnote
35] as well as the number of foreign trusts and certain bank accounts
owned by U.S. taxpayers overseas, while SEC collects information on
publicly owned companies with operations in foreign countries. For
example, for tax year 2004, approximately 1,402 foreign corporations in
the Cayman Islands were controlled by a U.S. corporate taxpayer,
according to IRS data. Those controlled foreign corporations in the
Cayman Islands accounted for more than $23 million in average total
income, placing them ninth among all jurisdictions in average total
income among U.S.-controlled foreign corporations reporting to IRS. Net
income earned from controlled foreign corporations in the Cayman
Islands ranks thirteenth among all jurisdictions in terms of all
foreign corporations controlled by a large corporate U.S. taxpayer. In
2002, the most recent year for which IRS had data, 193 returns were
filed by taxpayers indicating that they controlled a trust in the
Cayman Islands. This number accounted for over 7 percent of all
controlled foreign trusts in 2002. In terms of total income, U.S. tax
returns indicating that the taxpayer controlled a foreign trust in 2002
reported about $472 million in income and foreign trusts in the Cayman
Islands accounted for nearly 28 percent of that total, or about $132
million.
Any U.S. person with signature authority over or a financial interest
in an overseas account whose value exceeds $10,000 at any time during a
year is required to file a report called a Report of Foreign Bank and
Financial Accounts (FBAR) disclosing this information to the Department
of the Treasury. Failure to file this information can lead to civil
penalties, criminal penalties, or both. For those taxpayers with
signature authority over bank accounts in the Cayman Islands, the
number of FBAR filings for bank accounts in the Cayman Islands has
increased steadily since 2002, rising from 2,677 in 2002 to 7,937 in
2007 (see fig. 7).
Figure 7: U.S. Persons Reporting Cayman Islands Foreign Bank Accounts,
2002-2007:
[See PDF for image]
This figure is a line graph depicting the following data:
U.S. Persons Reporting Cayman Islands Foreign Bank Accounts, 2002-2007:
Year: 2002;
Number of reports: 2,677.
Year: 2003;
Number of reports: 3,152.
Year: 2004;
Number of reports: 3,725.
Year: 2005;
Number of reports: 4,839.
Year: 2006;
Number of reports: 5,735.
Year: 2007;
Number of reports: 7,937.
Source: FinCEN.
[End of figure]
In November 2007, 732 companies traded on U.S. stock exchanges reported
to SEC that they were incorporated in the Cayman Islands. Of these, 309
reported their Cayman Islands address on their filing. As part of their
annual SEC filings, companies must also disclose the existence of any
significant subsidiaries, either offshore or domestic. As of November
2007, 378 U.S. public companies reported having at least one
significant subsidiary in the Cayman Islands.
Because only limited third-party reporting is required by financial
entities in the Cayman Islands, accuracy and completeness of the
information are dependent on the taxpayer. For many taxpayers with
domestic transactions and accounts, IRS is able to match expenses and
income information provided by a third party to the taxpayer's return.
This approach has been proven to increase U.S. taxpayer compliance.
However, Cayman Islands financial institutions are often not required
to file reports with IRS concerning U.S. taxpayers. This increases the
likelihood of inaccurate reporting by U.S. taxpayers on their annual
tax returns and SEC required filings. The likely low level of
compliance with these requirements is an example of the general problem
with the completeness and accuracy of self-reported information.
U.S. Regulators Can Formally Request Information Regarding U.S.
Persons' Cayman Activities:
In addition to the information that both IRS and SEC receive from
filers of annual or quarterly reports, the U.S. government also has
formal information-sharing mechanisms by which it can receive
information from foreign governments and financial institutions. In
November 2001, as a result of negotiations between U.S. and Cayman
Islands officials, the United States signed a TIEA with the government
of the United Kingdom and the government of the Cayman Islands with
regard to the Cayman Islands. The TIEA provides a process for IRS to
request information related to specific identified taxpayers, their
specific transactions, companies, and named associates in respect of
both criminal and civil matters, including at the investigative stages.
The IRS sends TIEA requests to the Cayman Islands based on internal
requests from the Criminal Investigations division, in cases where a
taxpayer is under active criminal investigation, or from a revenue
agent conducting an examination of a taxpayer. In addition to the TIEA,
which is the newest international cooperation channel between the U.S.
and the Cayman Islands, the U.S. government and the Cayman Islands also
entered into a MLAT in 1986, which entered into force under U.S. law in
1990. The MLAT enables activities such as searches and seizures,
immobilization of assets, forfeiture and restitution, transfer of
accused persons, and general criminal information exchange, including
in relation to specified tax matters. Extradition from the Cayman
Islands to the United States is enabled under the United Kingdom's
United States of America Extradition Order of 1976 (as amended in
1986).
The TIEA is now the dedicated channel for tax information, while the
MLAT remains the channel for the exchange of information with regards
to nontax criminal violations. According to a Cayman Islands government
official, neither the TIEA nor the MLAT allow for "fishing
expeditions." Rather, as is standard with arrangements providing for
exchange of information on request, requests must involve a particular
target. For example, IRS cannot send a request for information on all
corporations established in the Cayman Islands over the past year. The
request must be specific enough to identify the taxpayer and the tax
purpose for which the information is sought, as well as state the
reasonable grounds for believing the information is in the territory of
the other party.
Since the TIEA began to go into effect in 2004, IRS has made a small
number of requests for information to the Cayman Islands. An IRS
official told us that those requests have been for either bank records
of taxpayers or for ownership records of corporations .[Footnote 36]
The IRS official also told us that the Cayman Islands government has
provided the requested information in a timely manner for all TIEA
requests. Since the MLAT went into effect and through the end of 2007,
the Department of Justice told us that the U.S. government has made
over 200 requests for information regarding criminal cases to the
Cayman Islands. A Cayman Islands government official told us that
assistance was provided by the Cayman Islands in response to these
requests in all but rare instances, and that when a request was refused
it was because it did not comply with the specific articles of the
treaty.
Some Financial Intelligence Information on U.S. Persons' Cayman
Activities Is Available to U.S. Regulators:
The U.S. government's financial intelligence unit, FinCEN, works to
gather information about suspected financial crimes both offshore and
in the United States. As part of the Department of the Treasury, FinCEN
is authorized, under the Bank Secrecy Act, to require certain records
or reports from financial institutions. Thousands of financial
institutions are subject to Bank Secrecy Act reporting and
recordkeeping requirements. As part of its research and analysis,
FinCEN can make requests of its counterpart in the Cayman Islands,
CAYFIN. CAYFIN can and does make requests to FinCEN as well. When
FinCEN receives SARs that involve connections to activity in a foreign
jurisdiction--such as the Cayman Islands--the agency can investigate by
requesting additional information from that jurisdiction's financial
intelligence unit. Cayman Islands law requires SARs from any person who
comes across suspicious activity in the course of their trade,
employment, business, or profession without limitation to financial
institutions. SARs generate leads that law enforcement agencies use to
initiate investigations of money laundering and other financial crimes.
Similarly, when FinCEN receives reports from institutions within the
United States that involve foreign persons it can disclose the
information to that country's financial intelligence unit. Certain U.S.
law enforcement and regulatory agencies also have the ability to review
SARs generated in the United States. If these agencies proceed with
further investigation and require additional specific information from
the foreign jurisdiction involved, the SAR-generated information can be
used to support an MLAT or TIEA request.
FinCEN and CAYFIN routinely share suspicious activity information. In
fiscal year 2007, FinCEN made 6 suspicious activity information
requests to CAYFIN. From July 2006 to June 2007, CAYFIN made 25
suspicious activity information requests to FinCEN to follow up on
potential new leads as well as existing Cayman Islands-generated SARs.
From July 2006 to June 2007, CAYFIN shared suspicious activity
information with FinCEN in 30 instances, and CAYFIN described 27 of
these instances as spontaneous in that CAYFIN disclosed suspicious
financial activity with a nexus to the U.S. without receiving a
specific request for information from FinCEN. The remaining three
information disclosures were responses to requests from FinCEN and were
related to active U.S. law enforcement investigations. According to
CAYFIN, financial institutions primarily filed suspicious activity
reports on U.S. persons for suspicion of fraud-related offenses. Other
offenses leading to the filing of suspicious activity reports included
drug trafficking, money laundering, and securities fraud, which mostly
consisted of insider trading. In addition, according to Cayman Islands
officials, statistics regarding SARs filed with CAYFIN show the United
States as the most frequent country of subject (30 percent of SARs).
Some Other Information Sharing also Occurs between U.S. and Cayman
Islands Regulators:
In addition to the formal information sharing codified into law between
the U.S. government and Cayman Islands government and financial
institutions represented by TIEA and MLAT requests and SARs, Cayman
Islands officials reported sharing with and receiving information from
federal agencies, state regulators, and financial institutions:
* According to CIMA, 40 requests for assistance were dealt with between
2003 and early 2008, including requests from SEC, Office of the
Comptroller of the Currency, Federal Deposit Insurance Corporation, and
various state insurance and banking regulators.
* CAYFIN reported informally sharing information with IRS criminal
investigators on several occasions in cases involving predicate
offenses such as drug trafficking or securities fraud.
* CIMA officials reported having traveled to the United States to do
due diligence on U.S.-based fund managers/administrators.
* CIMA reported that other nations' regulators have traveled to the
Cayman Islands to conduct onsite inspections of entities for the
purposes of consolidated supervision and Anti-Money Laundering/
Combating the Financing of Terrorism (AML/CFT) reviews. While SEC has
not conducted such inspections/reviews to date, CIMA indicated that it
has provided substantial assistance to SEC over the years and recently
facilitated SEC's conduct of interviews in the Cayman Islands relevant
to a current SEC investigation.
* The Cayman Islands Registrar of Companies maintains a limited amount
of publicly available information--company name, type, status,
registration date, and address of the registered office--about all
Cayman Islands-registered entities.
* CIMA officials stated that they regularly coordinate with U.S.
regulators at the state and federal level, and have several existing
agreements that structure the terms of coordination with these
agencies. For example, U.S. insurance regulators from Washington State
recently negotiated a Memorandum of Understanding (MOU) to share
information and coordinate with CIMA regarding cross-border insurance
matters.
U.S. and Cayman Officials Have Taken Steps to Address Illegal Activity,
but Enforcement Challenges Exist:
Tax evasion and other illegal activity involving offshore jurisdictions
take a variety of forms. Because the activity is offshore, the U.S.
government faces additional enforcement challenges.
U.S. Agencies Have Uncovered Illegal Activities with Cayman Islands
Connections:
While not unique to the Cayman Islands, 'hiding income offshore" is
fifth on the IRS's list of 12 most egregious tax schemes and scams for
2008. The IRS list cites several illegal practices, including hiding
income in offshore bank and brokerage accounts and foreign trusts, and
accessing this income using offshore debit cards, credit cards, and
wire transfers. IRS, SEC, and DOJ officials we spoke with described how
offshore schemes have been used to facilitate tax evasion, money
laundering, and securities violations. To address these issues, IRS's
SBSE, LMSB, and CI Divisions have several initiatives that target
abusive offshore transactions, and officials told us that some of the
cases that they have identified have involved Cayman Islands
connections. Still, a lack of jurisdiction-specific data prevents IRS
from knowing the full extent of Cayman Islands activity, and the Cayman
Islands was reported to be similar to other offshore jurisdictions with
regard to the types of activity that occur there.
For example, IRS's SBSE Division investigates leads referred from other
IRS areas, and also actively develops information sources that may
assist in identifying new areas of illegal activity. Several
initiatives have emerged from these two areas, including programs
focused on offshore credit cards, electronic-payment systems, offshore
brokerages, and promoters of offshore shelters. A program that we have
previously reported on is IRS's offshore Credit Card Summons project.
[Footnote 37] This program is a compliance initiative that seeks to
identify noncompliant taxpayers with offshore bank accounts,
investments, and/or other financial arrangements by "following the
money" associated with their credit-card transactions. This program has
been in effect since 2000, when a federal judge authorized IRS to issue
John Doe Summonses to U.S. credit card companies with banks in offshore
jurisdictions. IRS officials we spoke with explained that, since its
inception in 2000, this program has resulted in completed examinations
of over 5,800 returns, almost half of IRS's FBAR violation caseload,
and over $150 million in tax, $26 million in interest and $30 million
in penalties. Returns continue to be examined under the program. In
addition, officials reported that the program has placed pressure on
one credit card company to revoke the ability of an offshore bank in
the Bahamas to issue cards, and the Bahamas government to revoke the
bank's license.
IRS officials said that some abusive transactions identified through
these initiatives involved Cayman Islands entities or accounts,
although the exact extent of this involvement was unclear. IRS
officials indicated that jurisdiction-specific statistics were not
maintained, and thus comprehensive numbers on Cayman involvement in
abusive transactions were unavailable. One official also stated that
although illegal transactions had been detected, most of the offshore
business activity in the Cayman Islands was probably legitimate.
The LMSB executive with whom we spoke noted that there is no
jurisdiction-specific initiative involving the Cayman Islands. He also
said that the type of activity that occurs in the Cayman Islands is
similar to that in other offshore jurisdictions. Officials from LMSB
described several enforcement initiatives that involve the use of
offshore entities by U.S.-related companies and investment funds, and
reported that Cayman Islands entities have been involved in activities
under investigation by LMSB in a number of cases. For instance, LMSB
officials described ongoing investigations related to swap transactions
to avoid tax on dividend income, as discussed previously in this
report. IRS officials said that the rise of the hedge fund industry has
required them to devote resources to evaluating the changed business
environment and exploring legal issues associated with strategies by
industry participants to reduce U.S. tax burdens. According to IRS, it
now has a special team exploring the tax implications of specific hedge-
fund activities, including this arrangement, known as a total-return
swap.
LMSB has activity-specific initiatives for several areas that involve
offshore activity, including designated groups with expertise in
employment-tax enforcement and transfer-pricing schemes, issues
discussed previously in this report. LMSB officials stated that
transactions associated with these areas can be highly complex and may
involve aggressive but legal interpretations of the U.S. Internal
Revenue Code. For instance, LMSB officials said that it is legal for a
U.S. company to establish an offshore subsidiary to employ U.S.
citizens who work abroad, thereby avoiding Social Security taxes on
those workers in some circumstances. However, if IRS finds that a
domestic corporation is actually the true employer of the overseas
workers, it can challenge the legitimacy of the arrangement, leaving
the U.S. corporation liable for Social Security taxes.[Footnote 38]
LMSB officials involved in transfer-pricing enforcement described IRS's
activities in this area, and said that IRS has seen transfer-pricing
issues related to the Cayman Islands. They pointed out, though, that
Cayman Islands issues were similar to those in any other low-tax
jurisdiction. They also described several IRS efforts to counter
transfer-pricing abuses, including developing new regulations
publishing industry directives and providing guidance to field
examiners in cases involving transfer-pricing issues.
While some offshore activity amounts to aggressive, but legal,
interpretation of the Internal Revenue Code, the U.S. government has
identified multiple cases involving civil and suspected criminal
activity related to the Cayman Islands. Specifically, the IRS Criminal
Investigations Attaché who oversees requests related to the Caribbean
reported that over the past 5 years field agents had requested
information regarding suspected criminal activity by U.S. persons in 45
instances pertaining to taxpayers or subjects in the Cayman Islands.
However, the official also stated that the Cayman Islands had fewer
criminal violations than some other offshore jurisdictions. Department
of Justice officials told us that DOJ has prosecuted cases involving
the use of Cayman accounts and entities. We analyzed 21 criminal and
civil cases to identify common characteristics of legal violations
related to the Cayman Islands. Among these cases, the large majority
involved individuals, small businesses, and promoters, rather than
large multinational corporations. While they were most frequently
related to tax evasion, other cases involved securities fraud or
various other types of fraud. In most instances, Cayman Islands bank
accounts had been used, and several cases involved Cayman Islands
companies or credit-card accounts.
The documentation we reviewed for two of the cases, one referred to us
by DOJ and one found in our database searches, mentioned a Maples and
Calder connection. DOJ referred to us an ongoing tax case concerning a
taxpayer's participation in a number of sale-in, lease-out
transactions,[Footnote 39] some of which involved Ugland House
entities. IRS disallowed the tax benefits of the transaction and the
affected party paid the resulting tax assessment and was suing to
recover the amount at the time we did our research. A DOJ official said
that it did not appear that Maples and Calder initiated or promoted the
transactions. In the case found in our search, a hedge fund was
established as an entity with Ugland House as its registered office.
The U.S. hedge fund founder and manager has admitted fraudulent conduct
in the United States in the course of a civil enforcement action
brought by the Commodity Futures Trading Commission. The documentation
we reviewed contained no allegation that Maples and Calder acted
improperly. In neither of these cases did the activity in question
occur in the Cayman Islands. A Maples and Calder partner said that the
involvement of his law firm in these cases would almost certainly have
been limited to establishing the entities in question.
SARs also provide useful information about the types of potentially
illegal activity U.S. persons conduct in the Cayman Islands. As seen in
figure 8, most SARs disclosed by CAYFIN to FinCEN in 2006 and 2007 were
related to securities fraud, money laundering, drug trafficking, and
other types of fraud. These SARS were all disclosed to the United
States at the initiative of CAYFIN. CAYFIN tracks statistics on SARs
related to tax issues; however for the years in question, none were
reported related to the United States. Officials from Treasury and SEC
reported that the Cayman Islands has been cooperative in sharing
information and SEC reported that several of the SARs shared have led
to U.S. investigations.
Figure 8: U.S.-Related SARs Disclosed to FinCEN by CAYFIN in 2006-2007
by Type of Offense:
[See PDF for image]
This figure is a pie-chart depicting the following data:
U.S.-Related SARs Disclosed to FinCEN by CAYFIN in 2006-2007 by Type of
Offense:
Fraud: 30%;
Securities fraud: 20%;
Money laundering: 20%;
Drug trafficking: 17%;
Suspicious activity: 7%;
Pornography: 3%;
Terrorist financing: 3%;
Source: CAYFIN.
[End of figure]
Offshore Activities Pose Several Enforcement Challenges:
IRS and DOJ officials stated that particular aspects of offshore
activity present challenges related to oversight and enforcement.
[Footnote 40] Specifically, these challenges include lack of
jurisdictional authority to pursue information, difficulty in
identifying beneficial owners due to the complexity of offshore
financial transactions and relationships among entities, the lengthy
processes involved with completing offshore examinations, and the
inability to seize assets located in foreign jurisdictions. Due to
these oversight and enforcement challenges, U.S. persons who intend on
conducting illegal activity may be attracted to offshore jurisdictions
such as the Cayman Islands.
First, jurisdictional limitations make it difficult for IRS to identify
potential noncompliance associated with offshore activity. An LMSB
Deputy Commissioner said that a primary challenge of U.S. persons' use
of offshore jurisdictions is simply that, when a foreign corporation is
encountered or involved, IRS has difficulty pursuing beneficial
ownership any further due to a lack of jurisdiction. Specifically, IRS
officials told us that IRS does not have jurisdiction over foreign
entities without income effectively connected with a trade or business
in the United States. Thus, if a noncompliant U.S. person established a
foreign entity to carry out non-U.S. business, it would be difficult
for IRS to identify that person as the beneficial owner.
Additionally, the complexity of offshore financial transactions can
complicate IRS investigation and examination efforts. In particular,
offshore schemes can involve multiple entities and accounts established
in different jurisdictions in an attempt to conceal income and the
identity of beneficial owners. For instance, IRS officials described
schemes involving "tiered" structures of foreign corporations and
domestic and foreign trusts in jurisdictions including the Cayman
Islands that allowed individuals to hide taxable income or make false
deductions, such as in the cases of United States v. Taylor and United
States v. Peterson, as discussed previously. Further, LMSB officials
told us they had encountered other instances in which Cayman Islands
entities were used in combination with entities in other offshore and/
or onshore jurisdictions. One such instance involved an Isle of Man
trust used in combination with Cayman bank accounts in order to obscure
the beneficial ownership of funds. In another case, a U.S. taxpayer
used a Cayman Islands corporation, Cayman Islands bank, U.S. brokerage
account, U.S. broker bank, and U.S. bank to transfer funds offshore,
control the brokerage account through the Cayman Islands corporation,
and ultimately repatriate the funds to his U.S. bank account. One IRS
official explained that it can be more useful to "follow the money"
rather than follow paper trails when trying to determine ownership and
control in such situations.
Another challenge facing offshore investigations and prosecutions that
we have previously reported on is the amount of time required to
complete offshore examinations due to the processes involved in
obtaining necessary information.[Footnote 41] A senior official from
DOJ's Office of International Affairs indicated that the Cayman Islands
is the busiest United Kingdom overseas territory with regard to
requests for information, but also the most cooperative. She also said
that the Cayman Islands is one of DOJ's "best partners" among offshore
jurisdictions. Despite the Cayman Islands government's cooperativeness,
DOJ officials told us that U.S. Attorneys are advised that if any
offshore jurisdiction may be involved in a particular case, effort must
be made as soon as possible to clarify needed information and initiate
requests to obtain that information, in order to have sufficient time
to successfully receive and include the information. They said that
this is the case even with more cooperative jurisdictions, such as the
Cayman Islands, due to the processes involved in making a request.
According to Cayman Islands officials, they respond to MLAT requests
within an average of six to eight weeks, and their response time for
TIEA requests may be shorter. Past GAO work has shown that between 2002
and 2005 IRS examinations involving offshore tax evasion took a median
of 500 more calendar days to develop and examine than other
examinations. IRS officials from LMSB indicated that the specificity of
information needed to make requests was also an inherent limitation
involved in investigations of offshore activity.
Once noncompliance is determined, one LMSB official said that U.S.
authorities cannot seize assets in foreign jurisdictions. Assets can be
shared between the U.S. and foreign governments when an agreement
exists, though. A DOJ official reported that the Cayman Islands has an
agreement to share proceeds of criminal-asset forfeitures with the U.S.
government, and has been a very cooperative partner. The Cayman Islands
and U.S. governments have shared over $10 million from cases in which
the two governments have cooperated, and several million dollars have
also been returned to U.S. victims of fraud in other cases and in asset-
sharing with the United States since the inception of the MLAT.
The Cayman Islands Government Has Developed Safeguards to Prevent and
Detect Illegal Activity:
The Cayman Islands government has taken other steps to address illegal
activity by U.S. persons, in addition to supporting and cooperating
with U.S. government efforts. For instance, the Cayman Islands has
implemented a regulatory regime that IMF has found to be generally in
compliance with a wide range of international standards and has been
cited by the CFATF as having a strong compliance culture related to
combating money laundering and terrorist finance. In addition, CIMA has
supervision over various financial institutions in the Cayman Islands,
including banks; insurance companies; investment funds; trust
companies; and an array of service providers including insurance
managers, fund administrators, and corporate-service providers. CIMA
officials said that they do not regulate entities differently on the
basis of their residence offshore or onshore.
CIMA licenses financial institutions and service providers in the
Cayman Islands, and CIMA officials said that they consider several
factors in determining whether or not to issue a license, such as fit
and proper management, ownership and control, compliance with industry
requirements, compliance with industry standards, and consolidated-
supervision arrangements. In the case of the licensing of branches or
subsidiaries of non-Cayman Islands banks, CIMA officials stated that
they look to the foreign bank regulator in the bank's home jurisdiction
to ensure that (1) the foreign regulator permits the Cayman Islands
branch or subsidiary; (2) that the Cayman Islands operation will be
subject to consolidated supervision by the foreign regulator in
cooperation with CIMA as host regulator, in compliance with
international standards; and (3) that the bank proposing to open a
Cayman Islands operation is in good standing with its home-country
regulator. CIMA officials said that the same procedures would be
applied to any branches or subsidiaries of foreign trust companies that
are subject to regulation in their home jurisdictions.
CIMA officials said that they take a risk-based approach to supervision
of regulated financial activities, consistent with international
standards such as the Basel and the International Organization of
Securities Commissions (IOSCO) principles.[Footnote 42] They develop a
risk profile for the supervised entity, which then leads to on-and off-
site reviews of fund activity. In relation to on-site reviews of fund
administrators, CIMA looks at whether the different types of investors
are correctly allocated to the intended investment funds; usually done
with a 10 percent sample. CIMA officials said that some on-site
inspections are done outside the Cayman Islands, such as in New York,
Jamaica, and the Bahamas. Off-site reviews of funds include reviewing
offering documents, audited financial statements, supervisory returns,
and information provided by or available from regulators and other data
sources for red flags, such as regulatory breaches, violations of SEC
or United Kingdom rules, criminal charges, or any material related to
the fund's appointed service providers. While SEC has not conducted
such inspections/reviews to date, CIMA indicated that it has provided
substantial assistance to SEC over the years and recently facilitated
SEC's conduct of interviews in the Cayman Islands relevant to a current
SEC investigation.
In addition, CIMA officials said that captive insurance companies
organized in the Cayman Islands must meet certain requirements, such as
submitting a sound business plan, revealing beneficial ownership under
KYC rules, and identifying third-party administrators and actuaries.
Applicants first find an insurance manager in the Cayman Islands or
establish and staff a principal office in the Cayman Islands. Once the
entity is licensed, the manager provides audited annual financial
statements (an interim report if the next annual audit is longer than
12 months away) and other supervisory returns. CIMA officials said that
they meet with each company and the insurance manager every 18 to 24
months.
Finally, CIMA requires audits of its regulated entities to be submitted
within a prescribed time frame, and although the Cayman Islands has no
direct taxation, CIMA officials said that if an auditor saw a clear
criminal violation of another nation's tax laws, CIMA would expect that
to be in the auditor's report and would take it into account in any
invocation of its regulatory powers. Further, if at the licensing stage
there are any concerns or lack of clarity about the proposed business
activity, from a tax (or any other) perspective, then CIMA officials
told us that CIMA would require the applicant to submit a professional
legal opinion on the tax aspects of the activity.
In addition to administering regulatory safeguards, Cayman government
officials from the Financial Secretary's Office told us that they act
to implement regulatory standards and close loopholes when identified.
For example, they described a previous action by the Cayman government
to prohibit the establishment of shell banks.
Cayman Islands government officials and Maples and Calder
representatives stated that their role in helping the United States
ensure compliance with U.S. tax laws is necessarily limited. While
government officials stated that seeking to legally reduce or avoid
U.S. taxes would not be a legitimate reason to prohibit the
establishment of a company or trust in the Cayman Islands, if it was
clear that the entity was being set up as part of a scheme to evade
taxes or violate other U.S. laws, that activity would be recognized as
illegitimate and would not be allowed. As a matter of policy, and
practically, the Financial Secretary and Deputy Secretary stated that
the Cayman Islands government cannot administer other nations' tax laws
and are not aware of any jurisdiction that undertakes such an
obligation as a general matter. They told us that until a request is
made by the United States for tax-related assistance, the Cayman
Islands government is "neutral" and does not act for or against U.S.
tax interests. They said that at the point that a request is made, the
Cayman Islands can be relied upon to provide appropriate assistance.
They also said that the Cayman Islands would not be opposed to further
agreements with the United States regarding tax information sharing if
the international norms and standards supported such efforts, but that
there would need to be a clear justification for such agreements.
Senior partners from Maples and Calder that we spoke with stated that
complying with U.S. tax obligations is the responsibility of the U.S.
persons controlling the offshore entity, and that they require all U.S.
clients to obtain onshore counsel regarding tax matters before they
will act on their behalf. They added that they are not qualified to
advise on U.S. tax laws nor is it their role to enforce them, just as
is the case for U.S. lawyers when it comes to the tax laws of other
countries.
Concluding Observations:
Ugland House provides an instructive case example of the tremendous
challenges facing the U.S. tax system in an increasingly global
economy. Although the Maples and Calder law firm provides services that
even U.S. government-affiliated entities have found useful for
international transactions and the Cayman Islands government has taken
affirmative steps to meet international standards, the ability of U.S.
persons to establish entities with relatively little expense in the
Cayman Islands and similar jurisdictions facilitates both legal tax
minimization and illegal tax evasion. Despite the Cayman Islands'
adherence to international standards and the international commerce
benefits gained through U.S. activities in the Cayman Islands, Cayman
entities nevertheless can be used to obscure legal ownership of assets
and associated income and to exploit grey areas of U.S. tax law to
minimize U.S. tax obligations. Further, while the Cayman Islands
government has cooperated in sharing information through established
channels, as long as the U.S. government is chiefly reliant on
information gained from specific inquiries and self-reporting, the
Cayman Islands and other similar jurisdictions will remain attractive
locations for persons intent on engaging in illegal activity.
Balancing the need to ensure compliance with our tax and other laws
while not harming U.S. business interests and also respecting the
sovereignty of the Cayman Islands and similar jurisdictions undoubtedly
will be a continuing challenge for our nation.
Agency and Cayman Islands Government Comments:
We provided a draft of this report to the Commissioner of Internal
Revenue, the Secretary of the Treasury, and the Leader of Government
Business of the Cayman Islands for review and comment. IRS and the
Cayman Islands government provided technical comments, which we
incorporated as appropriate. In a letter to GAO, the Cayman Islands
Leader of Government Business expressed appreciation for the
opportunity to review and comment on the draft report. He said that the
report generally presents an accurate description of the Cayman
Islands' legal and regulatory regime and assists in clarifying the
nature of activity that takes place in the Cayman Islands. The letter
from the Cayman Islands Leader of Government Business can be found in
appendix I.
We will send copies of this report to the Secretary of the Treasury,
the Commissioner of Internal Revenue, and other interested parties.
This report is available at no charge on GAO's web site at [hyperlink,
http://www.gao.gov]. If you or your staff have any questions, please
contact me at (202)512-9110. I can also be reached by e-mail at
brostekm@gao.gov. Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this
report. Key contributors to this report are listed in appendix II.
Signed by:
Michael Brostek:
Director, Tax Issues:
Strategic Issues Team:
[End of section]
Appendix I: Comments from the Cayman Islands Government:
From the Office of the Leader of Government Business:
Hon. D. Kurt Tibbetts, JP:
Government Administration Building:
Grand Cayman KY1 9000:
Cayman Islands:
Tel: (345) 949-7900 ext. 2410:
(345) 946-6143:
Fax: (345) 949-2922:
E-mail; kurr.tibbetts@gov.ky:
July 18, 2008:
Mr Michael Brostek:
Director, Tax Issues:
Strategic Issues Team:
US Government Accountability Office:
441 G Street NW, Room 2A34:
Washington, DC 20548:
Dear Mr. Brostek:
The Government of the Cayman Islands wishes to express its appreciation
for the opportunity afforded by the GAO to review and comment on the
draft of this report and for the courteous and professional manner in
which the process was conducted by you and your colleagues.
Based on our review, we believe that the report generally presents an
accurate description of the Cayman Islands' legal and regulatory regime
and also assists in clarifying the nature of activity that takes place
in the Cayman Islands in its role as a global financial services
centre, to the benefit of both US and non-US persons.
We appreciate in particular that the report recognizes the high degree
of transparency and assistance provided to US authorities by our
government via an array of articulated cooperation channels that have
consistently proven effective and valuable in US law enforcement
efforts, including in relation to tax matters.
We look forward to continuing to assist US law enforcement agencies in
dealing with the enforcement challenges referenced in the report, where
we are in a position to do so. As the report recognizes, however, the
US Congress and those who are responsible for drafting and enforcing US
tax laws and regulations necessarily must play the principal role in
enhancing compliance with those laws and regulations by US taxpayers.
Signed by:
D. Kurt Tibbetts, JP:
Hon. Leader of Government Business:
[End of section]
Appendix II: GAO Contacts and Staff Acknowledgements:
GAO Contacts:
Michael Brostek, (202) 512-9110 or brostekm@gao.gov:
Acknowledgements:
In addition to the contact person named above, David Lewis, Assistant
Director, Perry Datwyler, S. Mike Davis, Robyn Howard, Brian James,
Danielle Novak, Melanie Papasian, Ellen Phelps Ranen, Ellen Rominger,
Jeffrey Schmerling, Shellee Soliday, A.J. Stephens, Jessica Thomsen,
and Jonda VanPelt made key contributions to this report.
[End of section]
Footnotes:
[1] Under the Internal Revenue Code, a United States person is (1) a
citizen or resident of the United States, (2) a partnership created or
organized in the United States or under the law of the United States or
of any State, (3) a corporation created or organized in the United
States or under the law of the United States or of any State, or (4)
any estate or trust other than a foreign estate or foreign trust.
[2] FinCEN, an intelligence and analysis organization, is part of the
U.S. Department of the Treasury's Office of Terrorism and Financial
Intelligence.
[3] GAO, Cayman Islands: Review of Cayman Islands and U.S. Laws
Applicable to U.S. Persons' Financial Activity in the Cayman Islands,
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-1028SP]
(Washington, D.C.: July 2008), an E-supplement to this report.
[4] Direct taxes are taxes on income, and may take the form of taxes on
personal and corporate income, social security contributions, and
payroll taxes.
[5] As of March 2008, 19 banks were licensed to conduct banking
business with domestic clients, while 258 were licensed to carry out
primarily international activities. U.S. banks are required to obtain
permission from U.S. regulators to establish a foreign branch or
subsidiary and are subject to consolidated supervision by both U.S. and
host country regulators. According to CIMA, other countries have
similar requirements and CIMA will not license a foreign bank absent
these prerequisites.
[6] The definition of a mutual fund under Cayman Islands law includes
funds with small numbers of investors.
[7] Estimates are from International Financial Services, London.
[8] More broadly, structured finance can refer to a wide variety of
strategies designed by investment bankers and others to help clients
obtain funding on desirable terms and in some cases with favorable
economic, accounting, and tax characteristics.
[9] According to CIMA, captive insurance arrangements enable companies
to lower the cost of insurance or obtain coverage not readily available
in the commercial insurance market.
[10] Maples and Calder, Maples Corporate Services Limited, and Maples
Finance Limited are collectively referred to in this report as
"Maples."
[11] For discussion of the role and requirements of businesses that
provide registered office services under Cayman Islands law, see the E-
supplement to this report, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-08-1028SP].
[12] For discussion of services required of a registered office under
Cayman Islands law see the E-supplement to this report, [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-08-1028SP].
[13] Cayman regulators refer to these requirements as "AML/CFT" (anti-
money laundering/combating the financing of terrorism). For discussion
of AML-KYC requirements under Cayman Islands law see the E-supplement
to this report, [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-
1028SP].
[14] Maples and Calder partners stated that they provide directors to
certain Cayman Islands companies, principally to structured finance
companies and investment funds, but do not provide nominee shareholder
services.
[15] See GAO Company Formations: Minimal Ownership Information Is
Collected and Available, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-06-376] (Washington, D.C.: Apr. 7, 2006). The lack of
requirements for beneficial ownership information in the United States
was cited by the Financial Action Task Force as a weakness in U.S. anti-
money laundering regulations. See Third Mutual Evaluation Report on
Anti-Money Laundering and Combating the Financing of Terrorism, (Paris,
France: June 23, 2006).
[16] For discussion of the use of nominees and bearer shares see the E-
supplement to this report, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-08-1028SP].
[17] For discussion of exempt, nonresident, resident, and foreign
companies under Cayman Islands law see the E-supplement to this report,
GAO-08-1028SP.
[18] Investment fund entities, structured finance entities, and general
corporate entities mentioned in the overview here are also discussed in
greater detail in the E-supplement to this report, [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-08-1028SP].
[19] Hedge and private-equity funds are similar in that they are pooled
investment vehicles that do not register with the SEC and attract
sophisticated investors. However, unlike hedge funds, private-equity
funds tend to invest in long-term highly illiquid assets.
[20] Maples and Calder partners noted that this estimate was generated
at our request and was made without systematic research.
[21] OPIC is a U.S. government agency that helps U.S. businesses invest
overseas, fosters economic development in new and emerging markets,
complements the private sector in managing risks associated with
foreign direct investment, and supports U.S. foreign policy.
[22] From this point forward SPV will be used to represent the SPE term
as well.
[23] For more detail see the E-supplement to this report, [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-08-1028SP].
[24] The Cayman Islands is also approved by the IRS as a jurisdiction
with acceptable KYC rules for purposes of the IRS qualified
intermediary program. See GAO, Tax Compliance: Qualified Intermediary
Program Provides Some Assurance That Taxes On Foreign Investors Are
Withheld and Reported, But Can Be Improved, GAO-08-99 (Washington,
D.C.: December 2007) for more information on the qualified intermediary
program.
[25] A Cayman Islands government official noted that this process is
similar to the regulatory process in the United States wherein notice
is given of proposed rulemaking and the public is invited to comment on
the proposed rules.
[26] U.S. persons may generally claim a credit for taxes imposed by
foreign countries, thereby avoiding or reducing double taxation.
[27] The law in this area is more fully explained in the E-supplement
to this report, [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-
1028SP].
[28] American Jobs Creation Act of 2004, Pub. L. No. 108-357, § 422,
118 Stat. 1418, 1515-20 (Oct. 22, 2004).
[29] GAO, Tax Compliance: Challenges to Corporate Tax Enforcement and
Options to Improve Securities Basis Reporting, [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-06-851T] (Washington, D.C.: June
13, 2006).
[30] See U.S. Department of the Treasury, Report to the Congress on
Earnings Stripping, Transfer Pricing, and U.S. Income Tax Treaties
(November 2007).
[31] Cost sharing arrangements between related parties, which involve
participants that agree to share the costs of developing intangibles
that will later be used by each participant, carry risks of transfer-
pricing abuse, especially with respect to the valuation of contributed
intangibles and the consequent compensatory buy-in payments for those
contributions. Similarly, pricing of certain types of services provided
between related parties, especially services performed using valuable
intangibles, may be particularly vulnerable to transfer-pricing abuses
[32] Cayman Islands government officials said that this is a common
problem when one country seeks information on activities within another
country.
[33] Statement by Defendant in Advance of Plea Guilty, United States v.
Taylor, No. 2:08-cr-00064-TC (D. Utah, Jan. 24, 2008); Statement by
Defendant in Advance of Plea Guilty, United States v. Petersen, No.
2:05-cr-00805-TC-DN (D. Utah, Jan. 18, 2008).
[34] GAO, Tax Administration: Additional Time Needed to Complete
Offshore Tax Evasion Examinations, [hyperlink, http://www.gao.gov/cgi-
bin/getrpt?GAO-07-237] (Washington, D.C.: March 2007).
[35] A foreign corporation is a "controlled foreign corporation" when
at least half of the foreign corporation is owned by U.S. shareholders
who own at least 10 percent of the stock. For more specific information
about the definition and consequences of a controlled foreign
corporation see the E-supplement to this report, [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-08-1028SP].
[36] The TIEA has been in effect for criminal cases since 2004 and for
civil cases since 2006.
[37] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-237].
[38] Section 302 of the Heroes Earnings Assistance and Relief Tax Act
of 2008, Public Law 110-245 (July 17, 2008) added subsection 3121(z) to
the Internal Revenue Code. Subsection 3121(z) states that, in general,
if a foreign company is a federal contractor and is a member of a
domestically controlled group of entities, then that contractor is
treated as an American employer for the purposes of the Social Security
taxes for its U.S. employees.
[39] In this sale-in, lease-out transaction, assets were sold to one
party and then leased back to the original owner or user. The
purchasing party then claimed certain tax benefits as a result of
ownership.
[40] Although we asked U.S. officials about the challenges they may
face in investigations of offshore activity, some of the challenges
they cited may also apply when investigating any non-U.S. activity.
[41] [hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-823T].
[42] The Basel Committee's core principles for effective banking
supervision are conceived as a voluntary framework of minimum standards
for sound supervisory practices in the banking sector. Committee
members include central-bank and regulatory officials from the United
States and other industrialized countries. One of the objectives of the
Basel Committee is to close gaps in international supervision coverage
so that no internationally active banks escape supervision and
supervision is adequate. IOSCO is the principal international
organization of securities commissions, and is composed of securities
regulators from over 105 countries. IOSCO develops principles and
standards for improving cross-border securities regulation, reviews
major securities regulatory issues, and coordinates practical responses
to these concerns.
[End of section]
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